Inflated pay for bankers: A problem with IT?

Why do some bankers get paid so much more than others with similar levels of expertise in other professions, e.g.:

• engineering,
• information technology,
• journalism?

There are two main answers: technology and technology.

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Asset management and investment banking (unlike, for example, the retailing industries (books, CDs, clothing) or hotels, travel and tourism (online reservations) has, to date, shut out technological competition, preserving high levels of rents (over the investment lifetime investment banks and asset managers who take approximately 30 per cent of the value of a typical personal pension, far too much for the safekeeping of a largely static investment portfolio). These rents are shared out between shareholders (compensating them in part, but only in part for the excessive charges made for portfolio management) and employees.

This is at last due to change: new technology, over the next 20 years, will transform asset management and investment banking as it has other industries. Disruptive change will lead to substantial dis-intermediation, profits and remuneration will fall dramatically – to the great benefit of investors who pay for all the bloated margins.

Banks unknowingly overpay their employees
Why though does so much of this margin go to the employees, not the shareholders? The answer is again technology. Bank management have hoodwinked bank shareholders: on the grounds of cost cutting, they have refused to spend the money on the IT systems that would accurately measure profit contributions of individual employees. The profitability measures for trading desks do not distinguish the impact of employee actions from all the various cross-subsidies (from government safety net, from other business lines) and crude market power. So not knowing what employees are worth, and in consequence scared of the impact of losing them, gives banks an excuse to substantially overpay their employees. This failure to invest in IT also underpins most of the large regulatory fines (Libor manipulation, failure to comply with KYC, etc) of recent years. To say this is a missed opportunity is an understatement.

Investors need to be more active…NOW
To solve these problems, what is needed is investor activism. As the ultimate clients, institutional investors and, equally importantly, the major sovereign wealth funds, have to get the industry to wake up to the 21st industry, adopt simple, transparent technology systems, open the barriers to competition and allow contributions of individual employees, NOW, to be adequately measured and therefore appropriately rather than excessively remunerated.

This Blog post is written by Professor Alistair Milne, Professor of Financial Economics and Director of the Centre for Post-crisis Finance.