If bankers can get a bonus, why not a pay cut too?

Tue Oct 14, 2008 1:13pm EDT
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By Dave Graham

FRANKFURT (Reuters) - Finance industry bosses should face the threat of pay cuts if they damage their firms by taking excessive risks, a new study said on Tuesday.

The proposal is part of an analysis of the credit crisis by the Frankfurt-based Center for Financial Studies (CFS), which said the current bonus system made executives more likely to take too many risks if bad decisions go unpunished.

The call coincides with threats by governments, including Germany and the United Kingdom, that as a condition of state aid, executives at struggling banks should be subject to pay restrictions -- which may mean they earn far less than before.

"It is essential to replace the bonus system by a bonus/malus system so as to discourage the manager from very strong risk taking," said the paper by Guenter Franke and Jan Pieter Krahnen, entitled "the future of securitization."

Malus is Latin for "bad." Bonus means "good."

This means if executives can win bonuses for a superior performance, they also need to be exposed to penalties such as salary cuts for presiding over failures, which can have ramifications for financial stability, Krahnen told Reuters.

"We think that in (the) future, it will be important to show investors to what extent incentives governing executives' future behavior are arranged in contracts," he said. "Up until now, not enough attention has been paid to this point."

The study stressed it was not a call for binding rules.   Continued...