Olivier Godechot: «Trader bonuses cannot be justified in any way!»

Mr Olivier Godechot , the results of your research on pay packages in finance are quite revealing! You refute the arguments used to justify the salaries of traders or salesmen…

Yes and it causes quite a shock among traders when I show them the results of my findings! Like Max Weber says, not only do they want to be part of an elite with strong privileges but they want their position to be justified as well. They counterattack with the arguments of work, results, performance and competence but although these are used in bonus negotiation, they cannot be considered as valid explanations. Merit is an ideological and moral concept which must be analyzed as such but is not key determinant as far as bonuses are concerned. If a classic explanation needs to be given to justify the level of the bonuses, it would be one where finance selects and reveals individuals with superhuman abilities which is something other sectors are incapable of achieving. This hypothesis is hard to refute but is in contradiction with market efficiency which being fundamentally egalitarian suggests the same rationale. I don’t believe in this superhuman hypothesis! We can also say that the people selected to work in finance have high graduate levels but when they are compared to other sectors such as retail banking, insurance, aeronautics and nuclear energy, the salary profiles are notably different from their previous fellow students!

Finance is a sector where profit contribution is very adequately measured. Is it not therefore rational to encourage people to earn a lot of money?

This argument makes some sense but I have a strong argument against it. I agree with the fact that we are in a sector where encouragement is key but that does mean that it should be detrimental and expensive to the employer and this can be demonstrated. Bonuses are like options and it is always better to have a single option than none at all. Some people will say that they are exposed to risk because their bonus is variable but it is always better to be exposed to risk that is always positive than nothing. As a counterbalance to this privilege, fixed salaries should be much smaller than those provided in sectors where they cannot be directly liked to results. But what do we see? With similar diplomas, sales and traders have higher fixed salaries than their colleagues in risk management, back office operations and even mergers and acquisitions but also have a higher bonus expectation. The latter is slightly higher than M&A and considerably bigger than back and middle office jobs. It is an abnormal situation in terms of market efficiency in the sense that people should not be happier in a job than another. They should globally have the same “utility” level.

Isn’t that an idealistic view of the job market?

No, it is way of comparing situations. We have a neoclassical mercantile logic that is unable to take into account these salary levels. This is where I will propose a survey that will seek on one hand to understand how everything takes place and on the other hand an explanatory system which attempts to provide an alternative way of clarifying the level of these salaries without including the superhuman hypothesis. The aim would be to understand how some individuals in finance find themselves able to accumulate a certain number of things which will transform a novice position (similar to graduate positions in all sectors) in a position where they will exert power on individuals, on the company, on shareholders and will obtain a return on that power.

But as an example, the traders at Société Générale bring in a lot more money compared to the other employees of the bank. A hundred of them bring in a more than thousand others and are very profitable. Isn’t it natural that the bank pays these traders much better than retail banking employees?

I do not agree with the term “natural”. We can say that if a company possesses a gold mine and if there are specific employees that will exploit the mine then the company has no good reason to pay them more than other employees. It’s the reason why an analysis must be carried out on the transformation process which converts the junior employee (with a small contribution) into an employee who brings a lot after 5 to 6 years. This is where an opportunity is given to some employees where they are told that if they have the right degree and if you do everything required then you shall be the holder of this profit machine. However, we are in a situation where the company will not benefit from the favour it is providing to its employee who will gradually take hold of this profit machine. They generate the flow without having to pay for anything. There are insensible transfers, flows which are unclear and which happen during the employee’s career. This place gradually and create a situation where elements linked to the collective environment will be his sole property. Everything that will come from his perimeter will be considered as his property and all that is linked to his work environment will be forgotten. There is a process (both symbolic and political) which will lead to building the legitimacy of the employee as well as his power. I have several examples to illustrate these situations and special attention can be given to the sales. The profitability of the sales will greatly depend on the quality of the client portfolio that he manages to build. He will at the beginning be given a small client portfolio with which he will evolve and if this portfolio grows, more brokerage flow will result. They will also “build” their own client portfolio and take more pride in the clients they have brought in themselves through their own efforts. They gradually forget that capturing clients is a collective effort which goes beyond their individual work, the time spent on the phone, pitching in line with the client’s thought process and client search beyond working hours. But the effort provided by the company to finance the sales, the work environment, the quality of the traders, execution and back office quality, will also contribute to capturing the client.

It is in this context that you talk about a “hold up”…

Yes, the sales will capitalize the ownership of the client on his own name. The work of the sales will be about making sure that the client be attached to him and not the company he works for. This is where a hold up situation takes place in the sense that the company has invested in building a client relationship but if the sales leaves, he will take away part of the client portfolio. The sales can threaten to leave with part of the client of the client portfolio and obtain the returns of the collective investment that has been carried out by the firm. In that case, the bonus will reflect the dividend stemming from a collective effort which will be for his personal benefit and it is in that specific sense that I believe a hold up takes place. There is a story which I mention frequently in my book about the Crédit Lyonnais in 1999 where two trading floor heads were threatening to quit. They told the bank that it had 48 hours to align itself to the salary proposed by competitors. It is exactly as if the director of a production plant had the ability to move the whole plant and its corresponding activity while negotiating with his hierarchy. These individuals had obtained between 7 and 10 million euros. They had the equivalent of 15% of the total bonus package given to a trading room composed of 150 sales and traders at that time. This share was quite unequal although it remained acceptable for the bank on a short term basis because it remained within the bonus pool of the sales and traders even if it is quite probable that the two trading floor heads indicated afterwards that the pool (30% of the value created) was becoming too small for the whole.

This is a situation that comes close to a scenario in a Western. I use the term Hold Up because there is a similarity between a western type illegal situation and the situation of these employees in the financial sector. But I also use this term because it is a technical concept stemming from economic analysis. I don’t want to label finance professionals as bandits. It is not my goal. They are absolutely right in exploiting a situation which is favourable to them and it is their job to do so – when we arbitrate a price, we exploit a situation which we consider as favourable and when we are employees on the labour market we also exploit situations which we consider as favourable. I don’t want to condemn those working in finance even more so since there have invented a revolutionary method which shifts the advantage towards working capital instead of the shareholders. They propose a way which is interesting from an employee’s point view.

However, your analysis would suppose that these traders are interchangeable and that in the end the individual ability of each trader or sales is minimized. Is that correct?

I maximize it and I minimize it at the same time. At the beginning of their careers, they are all equal but at the end, they are considered as irreplaceable. The bank is not in a position to replace them. If they were truly replaceable, anybody could take their place.

I am not saying that every trader negotiates in this way. Going till the breaking point does not happen very often even if the expression “If that’s the way it is then I quit” is frequently used when it’s bonus time. For example, a head hunter was telling me that a firm could ask him “I want anybody from Société Générale”. In such a case, we clearly see that it is not the individual but the technology of Société Générale which is of interest to the competitor. We are then in a situation where all the traders would be the owners of a valuable secret which generates a lot of money regardless of his contribution in discovering this secret. Each one of them could therefore leave with the marginal profitability of the secret if he or she was recruited by a competitor. We therefore see that they are employees who hold and sustain their activity. And this also contradicts a market representation in neoclassical terms: the theory of salary efficiency dictates that employees need to be paid according to the performance for which they are accountable rather than the one for which they are not. If this reasoning is held, it would be necessary to remove from the bonus everything that is linked to the global rise of the markets, to the overall economic context, to the increase in volumes…and when we see the formulas of bonuses, it is apparent that this rule is not followed.

There is paradox which is slowly emerging in the background and which is becoming a solid trend. It is one where traders believe that they are not properly being paid or think that they cannot make full use of their abilities due to regulatory constraints. This leads a lot of them to leave and create their own hedge funds so that they are indexed on the performance of their funds. Some traders manage to create value with teams of 5 or 6 persons! Doesn’t that express some skill? As an example, a certain John Arnold has generated 2 billion dollars by taking spread positions on natural gas….

Of course, what you are saying has its importance. The hedge fund is the salary utopia. It represents the idea of a trading which is freed from risk constraints as well as from capital and labour! It is an anarchical utopia! We are creating cooperatives in a temporarily autonomous zone. What I describe is quite general. Being a trader in the 1980s is not the same thing as being one in the 2000s. There is an evolution in terms of power relationships, division of labour and power sharing. In the 1980s, the head of a team compared to a trader is a peer among peers. They do approximately the same things, everything and anything, sometimes some selling, quantitative analysis, their own financial engineering, sometimes some back office functions…The chief is nothing more than a peer among others. But the logic of rationalisation is extremely strong in a trading room and the first among equals became an internal entrepreneur with an organisation that grew beneath him by work segmentation and division: arbitrageurs, market makers, quants, sales, back office, middle office…This means that instead of having people who initially knew how to do everything and consequently captured the global profit, we nowadays have people who are not as polyvalent and who do not have as much global knowledge as they used to during the eighties. In the current situation, the head of the desk and even more so the head of the trading room becomes the orchestrator. He divides the tasks, has an internal panoramic view and is the only one who can move the whole structure and coordinate a collective start. Consequently, he has a very large power within his hands, which is one of the reasons why the super salaries (10 – 20 million euros) are no longer those of the traders but those of the heads of desks. This work organisation causes the rise in power of the heads of desk and removes some of the prerogatives of sales and traders. The hedge fund ideal therefore becomes more tempting and allows a separation from this work organisation. It is the reason why the horizon of traders and sales consists in accumulating experience, get contacts, relations and skills in 5 -10 years, go beyond their situation and set up a hedge fund. But it is important to note that a hedge fund is not created out of nothing. When John Meriwether founded LTCM, he did not build it from scratch. He was nothing less than the head of bond trading at Salomon Brothers! He brought several former colleagues with him with part of the human capital trained at the bank. It is true that there are qualified traders and others which are not that good. Some are lucky, some not. It is however necessary to always have in mind historical and average performances.

What solutions do you propose to the various players of the financial chain?

Everything depends on who I talk to…

To sales and traders, I would tell them to get client exclusivity, become absolutely necessary and threaten their employer if they do not get the bonus that they feel they deserve…

To trade unions, I would say that finance has succeeded in shifting the power relationship in favour of the labour capital. Let us try to mutualize this rent and make sure that they are not exclusively meant for a small group of individuals.

To shareholders, I would say that we can try to pay lower salaries and generate more profits for them. All those advices run in contradiction with each other…

One the fields that banks could get inspiration from happens in American soccer. American soccer players are not as well paid as their European counterparts as the clubs cannot as easily recruit players from other teams. From the players’ point of view, it is a restriction on work freedom. From the owners’ point of view, it is a way of avoiding salary inflation while retaining the best players.

Maybe the banks could come to an agreement in order to avoid stealing traders and teams from each other. There are favourable factors such as bank concentration which if they continue will completely modify the labour market. However, the possibility of modifying he frontiers of capitalism through hedge funds threatens this ability to agree.

Some banks had tried to establish anti competition clauses that were limited to a certain place and a time frame. As an example, Société Générale had imposed some anti-competition clauses that were limited to the Paris area to some of its collaborators but that does not prevent them from going to Dublin, London or Amsterdam to create new entities…Recently, Calyon has sued an Asian bank which had stolen around 15 of its employees. It was the first time that such an action took place but I remain sceptical on the results.