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Stephen Hester’s pay deal discredits an entire bonus culture | Will Hutton

The government has failed as a shareholder and a regulator – clawing back money now will only do it further damage

An issue that unites Boris Johnson and Ed Miliband must have extraordinary political traction – and Stephen Hester’s near £1m bonus for his work as chief executive of RBS certainly has that. It is true that well designed and proportional incentives work, but those who defend Hester’s bonus in those terms have been shredded. Incentives designed with no sense of proportionality, no eye on the role of sheer good luck in the outcome, nor any care to design a process that is rigorous and legitimate, bring the whole apparatus of incentives into disrepute. Hester’s bonus passes none of those three crucial fairness tests.

The government may complain that it is obliged to pay bonuses under the terms of the employment contract agreed by the Labour government. That is disputed. What is not in dispute is that the government is the chief shareholder – but one conspicuous by its absence. Power existed that was not exercised.

The five categories that the RBS Remuneration Committee set for determining Hester’s bonus amount to no more than the job description for which he receives a base pay of more than £1m. Why should he be eligible for an exceptional bonus for executing strategy, hitting budgetary targets, meeting his obligations under Project Merlin, removing risk from the balance sheet and demonstrating his own capability while enlarging the capabilities of his staff? That is the job for which he is already paid more than 40 times as much as the median worker in the UK. The chief shareholder plainly took no interest – or was simply bamboozled by remuneration consultants and threats that unless the government connived in undemanding performance metrics, they would lose Hester and his top team.

What is revealed is the poverty of the current system of executive remuneration, especially in financial services. There is no inbuilt sense of proportionality in pay: no determined effort to link exceptional reward with exceptional contribution; no rigorous effort to separate out the luck of being in the right place at the right time from genuine effort and innovation; no mechanism to require executives to have some stake at risk, or some “skin in the game” to use Warren Buffett’s phrase; and a process in which the guiding principle is to give in to empty threats from executive teams. It is a one-way street in which executives in any circumstances always get more bucks or mega-bucks – never fewer bucks.

Business secretary Vince Cable announced measures last week to give shareholders still more power over pay and demanded a simple, transparent all-in figure for executive pay – declining the chance to reform remuneration committees seriously, require regular monitoring of the ratio of top pay to median pay, or ensure that executives should be required to put some of their base pay at risk if they want capitalist-type returns (known as earnback). Apparently No 10 did not want to offend business, watering down the proposals as much as possible. But retrospectively adjusting Hester’s bonus down will have made business no less worried.

It would have been better to set rigorous terms for Hester’s bonus beforehand, including earnback, and then stood by the result. But that would have required understanding business, being an engaged shareholder and political courage. None were on display.

Will Hutton chaired a government inquiry into top pay in the public sector, published in 2011 © 2012 Guardian News and Media Limited or its affiliated companies. All rights reserved. | Use of this content is subject to our Terms & Conditions | More Feeds