Why are bonuses still the sacred cow in banking?

  • By Christine St Anne

While there were some positives from the recent APRA report into executive pay a leading governance expert has questioned why the prudential regulator still remains focused on variable remuneration and calls for a freeze on bonuses. 

 On Tuesday, APRA released its proposals on executive pay which included a proposal to link 50 per cent of bonuses to non-financial metrics. 

APRA’s proposals focused on the balanced scorecard as the mechanism to improve inclusion of non-financial risks in remuneration performance measures. 

“I am disappointed that APRA still apparently puts so much faith in the balanced scorecard,” Macquarie University risk expert Professor Elizabeth Sheedy said. 

“Why is variable rem such a sacred cow in financial services? Millions of Australians go off to work every day and do a good job because it’s the right thing to do, not because they might receive a bonus,” she said.

Here, Sheedy points to a study she led on the balanced score which revealed that the approach failed and in fact supported further misconduct and bad culture. 

The Behaviour of Finance Professionals under the Balanced Scorecard study is part of ongoing Macquarie University research into the balanced scorecard and was supported by Deloitte Australia, the Insurance Council of Australia, the Australian and New Zealand Institute of Insurance and Finance, and the Financial Services Institute of Australasia.

The study assessed how various remuneration structures affect compliance with company policy.

According to the research, the highest rates (75 per cent) of compliance were achieved under a fixed remuneration structure, whereas compliance rates fell significantly (62 per cent) under a simplified balanced scorecard system.

It was a telling statistic. It came at the time of the Royal Commission hearings when Commonwealth Bank CEO Matt Comyn even admitted during the hearings that there was a link to bonuses and misconduct

For Sheedy while linking the management of non-financial risks with bonuses “sounds good in theory”, too much focus remains on the balanced scorecard. 

Millions of Australians go off to work every day and do a good job because it’s the right thing to do, not because they might receive a bonus

Sheedy highlights that the balanced scorecard applied will typically be judged subjectively by manager rating. 

“There is often doubt as to whether these ratings are credible and academic researchers have documented a range of problems with subjective management ratings due to various biases,” she said. 

For example, she said that centrality bias is the tendency to give all employees a similar rating, despite variation in performance, while leniency bias is the tendency to give higher performance ratings than are warranted. 

“Due to the large amount of managerial discretion in the ratings, and the desire to retain top performers in sales/profits, it is likely that managers may give a high rating to such staff despite poor behaviour.” 

Even more worrying, for Sheedy is that subjective performance ratings can be prone to favouritism, collusion and extortion as highlighted in her study. 

A lot of course will be dependent on “APRA being able to provide suitable oversight”. 

“We learned last week that their capabilities in this area are weak.

“A moratorium should be placed on staff variable remuneration until someone can come up with a way of making it work. What is also needed in this space is a lot more rigorously conducted research.” 

In its report, APRA did state that there may be other ways beyond applying the balanced scorecard to executive pay. 

“APRA is aware of emerging industry practices and that one preferred approach of some entities is to rely on Board discretion, using modifiers to determine and make adjustments,” it said in its report.

The prudential regulator said that it will seek industry feedback on other options to ensuring that non-financial risks, including misconduct risk, are explicitly included in remuneration measures. 

“In particular, APRA seeks comments on the merits of approaches that rely on Board discretion through the application of modifiers, rather than limits on the inclusion of financial metrics in scorecards.”