Bonuses and organisational type

By Paul Walker 06/03/2014

One of the amazing things about markets are the number of different organisational forms that appear as solutions to problems that people face. When it comes to business the most common form of organisation is the investor-owned firm. Another less common, but still widely seen, form of business organisation is the partnership in which the ownership rights are shared among the workers in the firm. In the UK a large retailing partnership is John Lewis.

At the Adam Smith Institute blog Eamonn Butler makes an interesting observation about people’s reaction to the payment of bonuses in investor owned firms and partnerships. He writes,

Staff at John Lewis are looking forward to bonuses totalling £200m this year. Everyone thinks this is wonderful, of course, as John Lewis is supposedly a fine example of a ‘mutual’, a ‘partnership’ that is owned by the people who work in the organisation.

Is John Lewis a mutual? Mutuals are run on the behalf of their customers, not their workers.

Staff at the Royal Bank of Scotland, meanwhile, are getting bonuses of £576m. Everyone thinks this is terrible, as the banks are thought ‘greedy’, not to mention mean to customers who want business loans.

The RBS bonus pot is just over twice that of the John Lewis bonus pot. But RBS has a turnover around 15 times that of John Lewis, £19.7bn compared to just £1.4bn. In terms of the size of the organisation, therefore, RBS bonuses are pretty trifling.

Why then do we see the different react to the paying of bonuses by the two organisations? Bonuses to bankers are often portrayed as going to people who are just ‘greedy’, just after the big bucks, while no one seems at all upset by the payment of bonuses to the staff at John Lewis. Why? Butler puts the issues this way:

But it is interesting that a bank can pay bonuses of less than a thirtieth of its turnover and everyone thinks it’s wicked, and a ‘partnership’ can pay bonuses of a seventh of its turnover and everyone thinks it’s a national treasure.

Butler goes on to argue that the different reactions just shows that the argument is all about politics rather than economic and business reality.

0 Responses to “Bonuses and organisational type”

  • Hmmmn, no.

    Bank execs are rarely owners of the bank – generally they are merely employees. So the “bonus” is a reward for exceptional performance, not a return on capital. Given the bonuses appear completely unrelated (if not unhinged…) to the ACTUAL performance of the bank, and the bonuses are regularly announced as being significant amounts well into 6 and occasionally seven figures,the public outrage is unsurprising. In the case of RBS, its especially galling given the requirement for taxpayer rescue only a few short bonus cycles ago…

    In John Lewis’ case, the “bonus” is seen as more like a shareholders premium – drawings even. And hell – its not like its taxpayers money with them…

    I am not saying the perception reflects reality. I merely point out that its somewhat disingenuous to claim a “political” motive to the public’s reaction.

    So, perceptions – yes. Politics, no.

  • The argument that turnover should be the de facto principle in the size of bonus has probably (only ?) emerged in the last 30 years or so.
    John Lewis seems to have generated profit that is about 5% of turnover. This is turnover of products bought in by the entity and sold by the employees (they are all “managers” after all). And looking at how this entity developed shows quite a “socially aware” philosophy when it was formed into a trust. One can then argue that any profit – which customers willingly contribute to by buying their product – is the trusts to do as they see fit. i.e. pay salaries and give their partners a profit share. This may be a euphemism for a “bonus” but it is certainly not in the same league at the RBS one.
    You claim RBS is an investor business. RBS is a bank. It plays with customer’s money – who are not the investors BTW. As far as I can see the investors in RBS are the taxpayers of GB. Hardly in the same context as “investors” in Vero or F&P for example. I suspect its main income stream is clipping transactions all along the way. Money in, money out; interest in, interest out; use of money in, use of money out. Then to really make more money on the clipper, multiply it by 10 or up to 30 times and then clip that lot in and out.
    So RBS has a turnover of $15B. They are not buying and selling “product” in the same way as John Lewis or Vero or F&P. They are taking forms of paper money and customers willingly (?) come along and pay interest on the opportunity to use that money in their business. Whose money is it? It certainly is not RBSs. It is those who have deposited money for “safe keeping” – and this includes poor RBS customers who got creamed when it needed bailing out. Interest may very well be 5% for money going out but it is invariably less than that for money coming in. For every transaction customers are forced to pay a fee. There is no “product” here. There is no asset being transferred. It is a service. But sure as hell there are millions of transactions that on a personal basis are a “small cost” to a customer but when multiplied by their thousands of customers pull in telephone numbers. John Lewis transactions are a one off business deal and if the shirt survives it will get replaced at the same John Lewis shop in another separate deal.
    Clipping money has become THE “Business of the Day”, nay year, nay decade. And banks have joined into this fray boots and all. This form of business is insidious. (And yes, I know where the term “clipping” came from. It describes this business perfectly).
    So no, I don’t think that turnover of these two entities can be used as prime examples for illuminating how different business entities are paying incentives or bonuses. One is selling product with a markup of the order of 10s of percent and pays a share of their profits. The other is clipping the millions for fractions of a percent and then has the gall to translate this pseudo “turnover” into exorbitant bonuses.
    And to cap it off:
    John Lewis has made a profit since 1999. Every year they paid a profit share. RBS on the other hand, at least since 2008, have made losses. The latest is $5.2B for a total of $46B in those six years. Note the B for Billion!! Yet they still paid out bonuses!!!!! Obscene is the only word that springs to mind.
    Your comparison of these two entities cannot possibly be considered fair. They are chalk and cheese.

  • Ashton. I’m not sure there is much of a difference here. The income side of ownership is just a contractual right to a part of the firm’s profits while an incentive scheme (bonuses) is also just a contractual right to part of the firm’s profits. If fact this similarity is part of the reason why a common economic definition of ownership is in terms of control rights rather than income rights.

    I think we all agree that the taxpayer rescue of banks should not have taken place but for this issue I’m not sure its relevant.

  • Ross. RBS is an investor-owned business – it is owned by its shareholders – as are most banks today. The bank is not, as you point out, owned by its customers, it would be a customer cooperative – rather than an investor cooperative – if it were. The RBS is providing a service for which customers are willing to pay, if not they can just keep their money under their mattress. There is no difference between profits that come from services – services make up most of modern economies – compared to profits that come from trading in physical products. Both sets of profits come from consumers being willing to pay more than it costs to supply whatever.

    As to RBS’s losses note that not all parts of the business make losses, and it is reasonable that staff in the profitable bits should be paid proportionately. Also even if some divisions are losing money, you might still want to keep paying them well, depending on how you think things will go in the future, and how much of an investment you have made in hiring and training up those staff members – not to mention keeping them out of the clutches of your competitors.

    Butler also makes the point that “Bonuses are actually a good way for an up-and-down business like a bank to manage their remuneration. Instead of paying high basic wages and having to lay skilled staff off when things go bad, you can simply slim their bonus, knowing that many or most will hang on in the hope of getting larger bonuses when things turn up again”.

  • So how can anyone justify bonuses of >$1m for “more than 100 senior bank executives” without choking on their cornflakes?

    Boy. I wish my company that was making losses compensated me for hanging around until they made a profit. Not! It was may fault it didn’t make a profit. But the RBS can justify the opposite. Strange really.

    This is the 1%s version of a ” good time was had by all”.

    • Agree that the bailouts were obscene; no argument there.

      But I can imagine large bonuses despite losses in situations where shareholders feared much worse losses. Dunno if it was the case here, but if the shareholders didn’t boot management for it….

  • Ross. It like asking why do Liverpool pay the likes of Luis Suarez or Steven Gerrard so much when they haven’t won anything in years. Its because they don’t want to lose them. Liverpool want to keep them out of the clutches of their competitors. What these people are worth depends on what a firm’s – including football clubs – competitors will pay for them.

  • One justification for their pay is that footballers have a limited lifetime in their career. But…….

    The “product” the clubs sell is “The Game”. (BTW To call Manchester City a “club” in the same sense as my Petone Hockey Club is a joke). People pay to see the game whether it is in the stadium or worldwide TV. This income from tickets and TV pays for the players and one presumes provides the income of the club. Unless you have Russian oligarch who will cough. Here is the rub. All those who watched the game got their kicks (sic), enjoyment, thrills and other emotional payoff. They got to see “their” over compensated (?) player score. That is their use of the product for which they will pay handsomely.

    Now the banks are a bit different. Customers who invest their money in the bank did it to keep thieves from taking it from under the mattress. Someone offered a safe place to put it. Ie a vault. That was the start. Others deposit their money so that they can make interest from it. Banks weren’t silly. They said let’s lend that equivalent to others so that the bank and the depositor can earn interest. A reasonable idea. However, when the system decided that you can do this 1, 10 then 30 times for each unit deposited then all hell broke loose. It was the invitation for shafting. The poor old depositor sure as hell is not getting his fair share of his unit getting lent out 30 times! No. What is happening is that the bank “borrows” the deposits – and any other money literally “floating” around – and gambles it on the financial exchanges of the world. Mega telephone numbers of $$s gets shuffled back and forth around the exchanges for merely clipping the ticket as the exchange rate cruises up or down. NZ foreign exchange dealings are of the order of NZs total annual income being gambled in days. I defy any economist to tell me that that is useful in anyway other than lining the pockets of bankers, financial dealers and prime ministerial whizzkids.

    A fibre optic cable is being put in between New York and London that takes a slightly shorter route between other links. Why? So that when the computer algorithms say sell or buy they can gazump the opposition dealers by approximately 34 milliseconds. The NY Stock exchange has servers through the wall that only selected financial institutions have access to. Why? So that they can gazump their opposition by microseconds.

    This. Is. Insane.

    This is the world that the likes of the RBS work in. I suggest the following comparison to football clubs might be useful: This banking system is like asking fans to pay for the tickets and pay TV to a football game and then the clubs GIVING the game away to anyone else who hasn’t paid for a ticket or pay TV to watch but allowing those who did pay to watch the kick-off.

    Now if that was happening, I too would object to players being paid that much. I argue that this is similar to what happened in the RBS.

    I don’t think this is an ethical, moral or right way of doing business. Just because it can be done does not make it right. The sad part of the banking example is that it is only a fraction of the world’s unethical business but is intimately tied to it all.

    I would like to see how economists justify this as “good” business. Further, I would love to see (m)any economics gurus research ways to change it and develop economic systems that don’t screw so many people (for any amount) rather than just comment on it or analyse ways of gaming such systems even more. It might make my kid’s life a little more agreeable.