Deficits, Game Theory, Individual v. Collective, Live and Learn, Trust

Are Bonuses Necessary for a Better Society?

By Iain Miller

It is currently Christmas bonus season in the world’s financial centres. Over the next few weeks the employees of the world’s largest financial organisations will be receiving the details of their annual bonus payments – a remuneration system that increasingly provokes outraged disapproval from sections of wider society.

Since the financial crisis began in 2008 and involved the widespread use of public money to support failing banks worldwide, governments and regulators have wrestled with ways to legislate and amend a pay system that is viewed by many as morally bankrupt, and destructive in its tendency to reward unsustainable short-term risk-taking. The Economist (4th Nov, 2010) succinctly encapsulated public feeling on the topic of banker’s bonuses with the following:

“It is a year since the investment-banking industry committed reputational suicide by paying bumper bonuses just a few months after the worst financial crisis in living memory. Outside finance, even red-blooded capitalists cringed in embarrassment. Bonuses were paid from profits buoyed by public subsidies—either directly through bail-outs or by central-bank interventions and implicit government guarantees.”

A year on, on the eve of another annual bonus round, the issue remains contentious. Over the last year in response to public and media disquiet, governments have moved to tax banks’ borrowing to claw back some of the public money they have been lent, and steps have been taken to revise the vexatious bonus pay system. Britain has imposed a one-off tax on bonuses this year, the USA has legislated to cap pay at organisations that are still in possession of bailout funds, and the European Union has formulated new rules for bonus pay that will be introduced next year.

But perhaps the anger and moral outrage over the gross payments made to a small minority of bankers is misplaced and misses a much bigger picture? Earlier this year (6th Jan, 2010), British newspaper The Guardian published an op-ed piece by Klaus Schwab, CEO of the World Economic Forum, which outlined his views on the wider social context within which we should approach the issue of corporate bonuses. In this article Mr Schwab outlined his belief in the ‘stakeholder theory’ of business, whereby large companies are viewed as a community, with its constituent social groups connected directly or indirectly to the business – all with a vested interest in its success and prosperity. The ‘social groups’ or stakeholders that make up this theoretical community are the organisation’s shareholders, creditors, employees, customers, suppliers, and the state and society in which business operates.

Mr Schwab argues that the recent furore over bonuses is superficial and distracts from a much bigger problem facing society. He attributes the recent financial crisis to businesses’ failure to acknowledge the existence and needs of their stakeholders, a trend in conduct that has potentially far-reaching negative implications for society:

“We have witnessed a gradual erosion of communitarian spirit over recent years. This erosion of societal values has progressed particularly in the business world, and is also one of the primary reasons of the current economic crisis.

The enterprise has transformed from a purposeful unit to a functional unit: the purpose of an enterprise – to create goods and services for the common good – in society has been replaced by a purely functional enterprise philosophy, aimed at maximising profits in the shortest time possible with the aim of maximising shareholder value. But if management decision-making processes are decoupled from the responsibility of managers for their own risk-taking, the entrepreneurial system becomes perverted.”

So by Mr Schwab’s argument, an erosion of moral values and a subsequent decline of a sense of duty to the wider community – with businesses behaving purely as profit-making machines – threaten future prosperity if business practices are not amended:

“The current crisis should actually sound the alarm for us to fundamentally rethink the development of our morals, our ethical norms and the regulatory mechanisms that underpin our economy, politics and global interconnectedness.

The financial crisis has led not only to an increasing level of unemployment that will remain with us for years to come. It also puts an enormous pressure on public goods and services, as governments are forced to pay off ballooning debts. The billions that are needed to pay off the debts will lead to higher taxes, reductions of social and public health systems, and reduced investments in education and infrastructure. In the end, it is the taxpayer, the average citizen, who pays for the costs of the crisis.

There is a real danger that the financial and economic crisis will develop into a social crisis. Difficult times lie ahead. If we want to keep society together, a sense of community and solidarity are more important now than ever before. This communitarian spirit is the basis of the stakeholder principle. We need to embrace that stakeholder principle, not just within the narrow confines of companies, but at a national and global level as well.

In the context of ‘stakeholder theory’, it can be argued that large profits and concomitant bonuses as a reward for productivity are by no means a negative thing. As stakeholders in societies where successful businesses operate, all stand to gain provided businesses are willing to play the role of benefactor within the states that support them.

Evidence of the possible beginnings of a shift in corporate behaviour in this direction emerged recently. On the 2nd Nov, 2010, prominent British politician and Mayor of London, Boris Johnson announced that Japanese investment bank Nomura will, this bonus season, be donating £150,000 to fund an after-school club for children in the London district of Camberwell. This charitable act is the product of discussions between Nomura’s top management and Mr Johnson during the annual convention of Klaus Schwab’s World Economic Forum in Davos in January 2010. Mr Johnson took the opportunity of the announcement to urge other wealthy bankers to use their bonuses to make a charitable investment to support their fellow stakeholders. One swallow does not a summer make, and it remains to be seen if the rhetoric of ‘stakeholder theory’ can materialise into a step change in business practices for the betterment of society as a whole.

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