When Bonuses Aren’t Discretionary

It’s becoming increasingly clear that if there’s a problem in the general economy with sticky wages — employers being unable to cut costs by cutting wages, and thereby going bust — then on Wall Street the problem is the other way around: wages aren’t sticky enough.

Rick Bookstaber writes today:

Employees in banks and investment banks get part of their pay bi-weekly over the course of the year, and then get the rest of their salary in the form of an end of year bonus. It is called a bonus, but a large portion of it is deferred salary. Even if they perform their job at a hum-drum level, they will still expect and get a sizeable “bonus”, because, however you want to put it in technical terms, the simple fact is that when they receive their bi-weekly paycheck, some of their pay has been held back. Taking away their year-end bonus would be like telling workers on a weekly pay cycle to return the second and fourth payment they received each of the last twelve months.

Now there are good reasons for having a bonus system: it incentivizes profitable work, and it makes it easy for banks to pay less money in lean years. But as Bookstaber writes, there’s definitely an implicit minimum bonus at investment banks — a sticky level below which it’s hard to cut bonuses any further.

There are reasons to have a minimum bonus, rather than baking that money into base pay: it’s not included in pay-rise calculations, for starters. But when banks start getting multi-billion-dollar government bailouts, it looks really bad if they then just turn around and spend a similar amount of money on bonuses.

And it really doesn’t help when the arguments in favor of bonuses look like this:

For an operations worker whose pay comprises $75,000 base and an expected 20 to 30 percent bonus, that final $20,000 or so may bridge the gap to owning an apartment, or sending his or her child to private school.

I’m sure it’s nice to be able to send your child to private school, but there’s no way you should be getting taxpayers’ money to do so: the government is, after all, already spending good money to allow you to send your child to public school, and in fact, at the margin, your local public school would probably be improved if it had a few more parents making $95,000 a year.

For any bank employees making less than say $250,000 a year, then, I’d encourage a policy of beefing up base pay and taking it out of bonus, to the point at which the bonus becomes genuinely, rather than merely nominally, discretionary. Beyond that level, bankers are grown-up enough to be able to negotiate their pay packages on their own, on the understanding that a bonus really is just that — a bonus — rather than something which has to be paid out, even in a year when your bank loses tens of billions of dollars.