To truly grasp the complexities and the changes surrounding the finance and banking industry, it is essential to understand the debate surrounding the contentious issue of executive pay reform. When the public discovered that AIG executives were paid excessive bonuses this year, they were angered and resentful in light of the fact that the company was the recipient of $170 billion of federal aid. For firms that are blamed for the onset of the financial crisis, the issue of pay culture reform is a thorny, but necessary challenge that they must tackle.
The central bank recently moved to incorporate reviews of compensation into its routine regulatory process, a step that many have long expected it to take. This translates into unprecedented government intervention into compensation schemes that are traditionally decisions of the management and the board. In addition, the highest earning executives at firms that received exceptional bailout will be capped at $500,000. While some (among them, European leaders) believe that pay-capping is long overdue, few actually expected the U.S. to actually implement these cuts. While the fed is not expecting to claw back executives’ bonuses the way UK Prime Minister Gordon Brown has suggested, nor introduce risk-adjusted returns to assess how employees should get paid; the move to overhaul compensation definitely signals a shift away from the Wall Street culture as it once was. The relevant question now is whether these measures will work – that is, to reduce the appetite for short-term risk taking? Or are they only cosmetic changes? Critics have pointed out that the reduction in cash payments is merely compensated by stocks, or that a reduction in the bonus structure will only entail a shift to more salary. The most worrisome aspect of this issue for banks is whether it will spark an exodus of top talent, not only to other domestic banks, but also overseas, as other G20 countries such as Brazil, Japan and China do not feel the same urgency to scale back their executives’ pay.