Following the financial crisis, there has been a growing concern over the long-established bonus policy that exists in various financial institutions.
In Europe, since 2014, banks have been forced to limit the size of bonuses for their senior staff to twice a banker’s basic salary. Yet regulators are still looking to curb excessive pay in firms other than investment banks. With asset management firms being generous in giving out bonuses to their staff in recent years, the public are gradually pointing towards the bonus culture in asset management firms. Though the European MEPs narrowly voted against the bonus cap in the asset management industry in 2013, academics and regulators are still seeking the opportunity to push forward a bonus cap among senior staff in asset management firms. The theory that bonuses encourage short-sighted behaviour and unnecessary risk taking actions is even supported by some fund managers, for example UK investor Neil Woodford, who eliminated bonuses for staff at their companies.
The public discontent towards the bonus culture is understandable, yet a bonus cap on fund managers would not necessarily safeguard the interests of the investors. In fact, the measure would even put investors in a more disadvantaged position. A bonus based on performance aims to align the interests of the fund manager with the client/investor. An outperformance will simply reward both parties. It provides a great incentive for fund managers to put their utmost effort into managing the funds and making the best possible investment decision, as they know they will be rewarded for their effort and skills. Consequentially, the clients/investors can enjoy the best possible services rendered by the fund managers and reap significant returns. If a cap is placed, it is highly likely that the fund managers will be discouraged to stay ambitious and work hard, as they will not be justly compensated for their effort and time. This, in fact, leads to a failure in protecting the clients/investors’ interest as the general public are left with ineffective fund managers.
To prevent such an outcome, employers are likely to resort to raising the fixed salaries of their fund managers to encourage them to stay ambitious. This, in return, increases the firm’s operation costs and business risk. A higher fee from clients will thus be needed to compensate for the rising operation costs, which once again will do more harm than good to the clients.
It is inevitable that there has been a serious erosion of trust between financial institutions and investors ever since the global financial crisis. The public is skeptical towards the fees paid to fund managers as well as how the managers manage their money. There is a constant fear that their hard-earned money will be dissipated by these ‘bloodsuckers’. Therefore the regulators always have the upper hand on this area and the risk of over-regulation looms large. Perhaps the best method to address this issue of mistrust is by providing a greater degree of transparency as to the fees paid, sources of risk and the managers’ bonus systems. By disclosing the remuneration scheme, it helps link the skill to success and can better assure investors’ concerns.
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