Global banking giant HSBC and Warren Buffett's Berkshire Hathaway should be paying staff the biggest bonuses, according to a new bonus model from a management consultant.
The two groups top a list of financial institutions measured by the new method from consulting firm Stern Stewart, as the industry seeks to address concerns over the short-termism partly blamed for sparking a global banking meltdown.
Erik Stern, managing director of the firm, is trying to get financial firms to adopt his Relative Wealth Added (RWA) model to measure bonuses, saying it can align executive and shareholder interests.
Many managers were paid especially well because markets were rising, including those whose firms performed worse than peers. They had good fortune, were they managers of premier league clubs, they would probably have been fired, Stern told Reuters in an interview.
Stern's company is known for its widely-used concept of Economic Value Added (EVA), which it says turns a firm's accounting book value into economic book value, and measures whether shareholder value has been created.
The EVA model, credited by many for a turnaround at Coca Cola, forms the basis of the new calculation, RWA.
Using its new calculation, Stern identifies HSBC and Berkshire Hathaway among the worst performers during the economic expansion between 2002 and 2007, but the best two performers since.
They were also among the best over the whole 2002-2009 cycle, alongside players like Goldman Sachs. The worst performers were Citigroup and AIG, which ranked near the bottom in both the expansion and contraction phases of the business cycle.
Companies can encourage executives to take only those risks that align the long-term corporate interest with that of investors, by using the right measure of long-term performance and using the right compensation structure, Stern said.
For example, in the case of options awards, most of these should begin to vest after a number of years, with no short term vesting, Stern said.
If bonuses are paid in shares, executives should have to hold some of them until after they leave the company, otherwise they may take decisions that boost profits and their bonuses in the short term but may damage the company when they are gone.