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.
“No regulation is required, only transparency on remuneration policy, including an independent assessment of incentive properties of the scheme,” it said.
Krahnen, a professor of finance at the University of Frankfurt, said there were many ways in which the concept could be applied, but that it should be present in some form.
The two authors are due to present their paper on Thursday at the Brookings Institution, an influential Washington-based think-tank, Krahnen said.
“Everything we’ve seen so far on the financial turmoil are crisis measures, but none of them have a long-term perspective,” Krahnen said. “This is what we were focusing on with our paper.”
On Monday, German Finance Minister Peer Steinbrueck said executives at banks seeking capital injections from the state should not receive more than 500,000 euros ($683,100) per year — or any bonuses, dividends or severance pay.
The CFS describes itself as a non-profit research body, supported by an association of over 120 banks, insurers, industrial firms and public institutions. Its president is Otmar Issing, the former chief economist of the European Central Bank.
To see the report, double click on:
Reporting by Dave Graham; Editing by Sharon Lindores