Financials Unshackled Issue 4: Irish Banker Pay Caps
Discussion Note on the origins of Irish banker pay caps, recent developments and where things stand today, and how it might all play out from here
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Prelude
This is a lengthy Discussion Note. I have bolded sentences throughout so one can navigate it easily. If you want to skip straight to recent developments / the current situation, I suggest scrolling straight to Section 3 (of 8).
1. Background to the remuneration restrictions
Following the collapse of Lehman Brothers in 2008, it became increasingly evident that the Irish banking sector was in a parlous state and in much need of financial support. The then Government moved swiftly to institute a – now infamous – guarantee arrangement covering all deposits, covered bonds, senior debt and dated subordinated debt (lower Tier 2) for a period of two years with AIB, Bank of Ireland (BOI), Anglo Irish Bank, Irish Life & Permanent (the precursor to today’s PTSB), Irish Nationwide Building Society, and EBS (now AIB). The Credit Institutions (Financial Support) Act, 2008 (which became law on 2nd October 2008) provided the legislative underpin for the guarantee arrangement and also facilitated the (subsequent) provision of financial support by the Minister for Finance to the aforementioned credit institutions.
In exchange for the pledged supports, the then Government, understandably, wanted to see some pain taken by the caretakers of those institutions and, amongst other measures, the Covered Institutions Remuneration Oversight Committee (CIROC) was duly established under the terms of the 2008 Act. Its remit was to oversee all remuneration plans of senior executives of the covered institutions. CIROC recommended CEO salary caps of €690k p.a. at both AIB and BOI and a CEO salary cap of €545k p.a. at Irish Life & Permanent. However, the Government went further, setting a limit of €500k p.a. on CEO salaries at each of these institutions – as well as a complete ban on variable remuneration for all staff (indeed, legislation was also enacted around that time to impose a supertax of 89% on any Irish resident banker bonuses of >€20k) – with the then Finance Minister remarking: “We are fighting for our financial and economic survival…Those who earn most must be seen to pay most and to give up most”. So, a political move in response to the travails of the time – but that was almost 16 years ago.
2. A decade of wrangling yielded no change
As the financial condition of the Irish banks improved considerably through the course of the last decade (i.e., through the 10’s), the banks increasingly began to warn about the impact of these pay restrictions. Even if one casts their eye back to the 2016 BOI Annual Report (just to pick one), the warnings were clear: “The Remuneration Restrictions place the Group at an increasing competitive disadvantage in seeking to retain and attract staff, particularly those with certain skill sets and in international locations”. Indeed, AIB’s IPO Prospectus in May 2017 noted that “…the absence of market-aligned short- and long-term variable incentive schemes restricts AIB’s ability to align the remuneration of key executives with the achievement of strategic plans and prevents it from creating a lock-in to ensure achievement of those deliverables. This may have the effect of a loss in senior management and may lead to a change in the strategic ambition of AIB.”. Just over a year later the then CEO of AIB Bernard Byrne noted (in July 2017) that a “mid-teens” percentage of AIB’s almost 200 most senior managers had resigned since the IPO. And, as if the cautionary language enshrined in the AIB IPO Prospectus were prophetic, 2018 saw the resignations of not only the then AIB CFO (Mark Bourke) but also the then CEO (Bernard Byrne) – with both taking up what were widely understood to be materially better-paid roles elsewhere.
In 2018 the then Finance Minister Paschal Donohoe commissioned the global consulting firm Korn Ferry to review the crisis-era pay restrictions (the process to appoint Korn Ferry started prior to the then AIB CEO’s resignation to be clear). However, the report was not published*. Continued efforts on the part of the sector – with the most notable regular advocates for a lifting of the pay restrictions being the Chairmen of BOI and AIB (in that order arguably) – to address the compensation restrictions yielded no change and nothing happened until the divestment of the State’s final shareholding in BOI effectively ‘forced the issue’ in part.
3. Repeal of pay caps at BOI in 2022; some softening of other restrictions
The Government announced that it had completely exited its investment in BOI in September 2022, noting that it had received cash proceeds of almost €6.7bn in return for its €4.7bn investment in the institution (as an aside, the State is now, notably, verging towards break-even with respect to its investments in AIB). Government then moved, in late 2022, to repeal the pay caps applicable to BOI (following the publication of the Department of Finance-led Retail Banking Review, which recommended this). The Government also agreed that the pay caps applicable to AIB and PTSB executives shall be removed when the State’s shareholdings in those banks falls to a “specified appropriate level”. Other changes agreed were to permit the banks to pay bonuses of up to €20k p.a. to staff members and to permit the reintroduction of certain fringe benefits for staff (health insurance, childcare costs) which had also been curtailed in response to the GFC-era financial support measures.
The proponent of these changes was Paschal Donohoe, the then Finance Minister. Naturally he took some flak for sponsoring these changes with members of the Oireachtas Finance Committee capitalising on the moment to criticise his decisions (to put it mildly). However, it was also, arguably, an astute political move to only go ‘so far’ and to pass the baton to the incoming Finance Minister Michael McGrath with respect to what to do, in particular, about the pay caps that remained in situ for AIB and PTSB (the decision to remove the pay caps at BOI was entirely defensible (and, arguably, unavoidable) given the State had no longer any economic interest in the institution – and the other measures were arguably ‘at the fringes’).
Of most particular note, in my view, was the suitably vague reference to the “specified appropriate level” that the shareholdings in AIB and PTSB would need to fall to before the caps would be removed in the case of those institutions. This led to widespread speculation around what that level would be – with institutional investors taking significant interest in the debate at the time. Lo and behold it emerged, via a FOI request in subsequent weeks, that earlier drafting had specified that the threshold would be <50% (for clarity, the Government still held a shareholding of >50% in AIB at the time). One would be forgiven for speculating that it was absolutely never the intention to commit to removing the pay caps when the shareholdings in AIB and PTSB fell below 50% (which could also have had the effect of raising the political sensitivities in relation to further selldown decisions) but, by ensuring that such a specification was incorporated in earlier drafting, it would, were that information to ever become public (which it now has), facilitate ‘testing the waters’ for such a move (observing the public reaction to that suggestion) and, possibly, anchoring the debate on a number other than zero (as well as, potentially, appease the AIB and PTSB bankers to an extent).
4. No further movement since the change in guard at the Finance Ministry
While Donohoe’s immediate successor Michael McGrath remained committed to the bank shareholdings divestment process, no further changes have been effected to the remuneration regime. To be fair this is hardly surprising. Even though the State’s shareholding in AIB reduced to a level considerably below 50% during his tenure, it would have been far more controversial for McGrath to remove the pay caps at AIB (while the State still had a shareholding in the institution) than Donohoe’s decision to repeal the pay caps at BOI after the State had fully divested from that institution (moreover, the supertax hasn’t even featured in the debate in recent years). This is especially the case given that the change in guard at Finance Minister level came at the start of the second half of the current coalition Government’s term with the next General Election naturally becoming much more of a focus at that point – and given that, until recently, it appeared that the re-election of the current Coalition Government was at great risk from the rise in support for Sinn Fein. Furthermore, the new Minister for Finance Jack Chambers (appointed in June 2024) has, unsurprisingly with an impending General Election looming large, categorically ruled out any further loosening of restrictions, commenting to reporters in the aftermath of the State’s sale of a c.5% shareholding in AIB in late June: “Removing the salary cap isn’t something I’m considering presently and it will be maintained over the coming period”. It could be argued that any other decision would have amounted to ‘political suicide’ at that juncture.
5. The fixation is on top executive pay – important, yes; but not the full picture
Most efforts on the part of the sector to address the remuneration restrictions have focused on top executive pay caps. Indeed, the Korn Ferry document reportedly recommended that bonuses of up to a maximum of just €20k p.a. should be permitted to the broader staff universe. However, this recommendation may have been influenced by the harsh political reality that a supertax of 89% applies to bonuses above this threshold – and, possibly, in a bid to avoid political fireworks by going further in this vein. To be fair, Korn Ferry did reportedly recommend that other benefits such as childcare and healthcare of up to 30% of basic salary should be permitted. However, cost flexibility matters from a credit institution perspective and incentives work from an individual and team performance perspective. In my view there is far too little debate on the supertax or on the variable remuneration restrictions (interrelated, i.e., the restrictions are – arguably – a function of the supertax) and this obsession with top executive pay is only one side of the story.
Indeed, it could be argued that what the variable remuneration restrictions – and the supertax – have done is create a perception amongst the wider existing and prospective employee universe that talent cannot be adequately rewarded at the Irish banks.** We only hear about the very top level moves but what about the loss of key staff below the very top layer (going back to Byrne’s 2018 comments, for example) – and we absolutely have seen very high-quality departures below the top layer. Now, I’m all for structural cost containment (which will become more important in the medium-term in a lower official rate environment – and, in the longer-term, as the competitive landscape evolves). But the facts are that the banks need talent to counter the competitive challenges that they will encounter on a longer-term view (acquiring the best-in-class AI / customised product development / associated risk management / etc. personnel requires significant investment) and they will need to incentivise selectively to acquire / retain the right talent. Indeed, it has been well-documented across the wider industry that variable remuneration restrictions only serve to inflate fixed pay – which is a significant structural issue and I don’t need to start on the wide body of research that proves that incentives (upside potential) work! That all matters at top executive level too, of course.
Further on this point, it’s not as if the Irish banks (or most banks elsewhere) are printing ‘supernormal profits’ owing to great innovation. It’s predominantly a function of massively suppressed domestic deposit pricing (despite the fact that depositors have ample opportunity to eke out much better returns on their monies – even within the same institutions) – though, with that said, the banks have been managed well under the existing (and recent) executive cohort (sensible capital allocation, well-timed strategic acquisitions and disposals that presented compelling industry logic, much-strengthened risk management, astute structural hedging strategies, political nous, etc.), which has facilitated the Department of Finance delivering a positive outcome for the taxpayer. Indeed, the danger is that the current exceptionally strong returns enjoyed by the banks has the impact of masking the issue (and the fixation on the top brass getting paid means that the wider variable pay restrictions are not part of ‘the conversation’).
But, put simply, every industry evolves – and, despite regulatory perimeters, the Irish banks are not immune to disruption either in the longer-term. This means they will need to ‘up their game’. Maybe it’s not going to be an especially pressing issue for the current management teams (taking into account industry average executive tenure) but, still, they need the right long-term strategic priorities and the right talent to execute effectively on those priorities. Nudging up fixed pay might help retention in the short-term but it is well-documented that the secret sauce to driving outstanding performance is incentives (not to mention the challenges that structurally high fixed pay can bring in times of difficulty). Put simply, incentives will be necessary for the banks to hold onto their best people and to be positioned to attract the best talent – and, indeed, to ensure that the right people are being groomed for the top roles in due course. Indeed, we are now seeing poaching efforts amongst the new digital entrants play out at the highest levels according to a recent report in The Irish Times to the effect that the PTSB CFO Nicola O’Brien (who resigned in late August) is set to take up a senior position with Monzo (who recently noted that Ireland will serve as the gateway for a European expansion initiative) – OK, I hear you – another top-level executive example, but where one goes others will follow.
6. Getting back to the top executives – are they actually massively underpaid? Yes is the short answer
It’s a fair question to ask as to whether the current crop of executives are actually underpaid. The market for top bank executives is international and is like any other economic market – those who can get paid handsomely will generally gravitate to where they will get paid handsomely (which doesn’t necessarily have to be in banking) unless there are other motivating factors. The BOI Remuneration Committee has exercised considerable restraint since the executive pay caps were repealed. The CEO is on what would be considered an exceptionally modest salary of €950k relative to peer CEOs of similar-sized banks in other jurisdictions (especially given highly limited other compensation benefits) – but BOI has the flexibility to push that up and one would be forgiven for arguing that the decision to maintain the package at a keen level for now is, at the very least, an attempt to ‘read the political tea leaves’.
While the CEO and CFO departures from AIB brought the issue to the limelight a number of years ago, we haven’t seen very many top executive level departures since then that one could conclusively blame on the pay caps – arguably with the exception of Francesca McDonagh’s*** decision to resign from BOI in 2022 (though that appeared to be an upward career move at the time in any event so even if she had been paid double what she was on the question beckons as to whether she would have moved anyway). And most of the bank Executive Directors have been with the institutions for many years now despite the caps. Could it therefore be argued that, if these individuals could get paid much better elsewhere, they would have left by now?
On balance, I think it’s fair to assert that: i) we have seen enough top-level exits in overall terms (with the recent news that the PTSB CFO has now resigned too) to argue that the remuneration of top executives is sub-par and is not conducive to retention of the best talent; and ii) the reason why many of the current top executives have ‘sat it out’ is potentially partly (at least) because a sense of optimism has prevailed that something will be done (notably, in this context, the PTSB CFO who has just resigned joined the bank as far back as 2017). However, they are not going to wait forever. And, in terms of some international benchmarking, David Duffy, the CEO of Virgin Money UK and former CEO of AIB received a total compensation package of £2.65m for the financial year to 30th September 2023 – and VMUK is a fraction of the size of AIB and BOI in terms of market value. Indeed, Adrian Sainsbury, the CEO of Close Brothers in the UK, received a total compensation package of £1.05m for the year ended 31st July 2023 in what was a tumultuous period for the group (and received a total compensation package of £1.6m for the previous year) – for context, Close Brothers’ market capitalisation is less than £800m at the time of writing. It is undeniable that the top executives are massively underpaid on a relative basis.
7. How is it going to play out from here – and what should happen?
Put simply, nothing is going to happen until post-General Election in my view. It would amount to the incumbent Government handing the opposition a strong stick to beat them with – as should be evident when one reflects on the Sinn Fein Finance spokesman’s comments to Finance Minister Donohoe in November 2022 on the relaxation of some of the remuneration restrictions: “People are shocked that your parting gift is a bonus for bankers”. Right now, we don’t know when the General Election will be held (late 2024 following a likely ‘giveaway Budget’ on 1st October seems most likely), which parties will be elected or who the next Finance Minister will be. Judging by voter polls, the most likely outcome is that Fine Gael and Fianna Fail will capture a sufficient share of the vote to form a coalition government again, with Sinn Fein unlikely to be in government – but it’s not a fait accompli either.
I suspect the base case thinking in government circles is that, if such a political outcome manifests, the State will continue to expediently divest of its shareholding in AIB (which now sits at <22% following the completion of the €500m buyback last week) and will remove the pay caps in their entirety once the State’s shareholding in AIB falls to zero (it seems like it would not be too controversial to impose a blanket repeal rather than leave the restrictions in situ just for PTSB at that point). That could be within the next 12 months, all going well – and everything could go according to plan (assuming my view on the ‘base case thinking’ isn’t far off the mark). There is, of course, a prospect that the next Government will move sooner (i.e., while it still has a shareholding in AIB) – and that’s what should happen in my view, but my suspicion is that it won’t happen that fast.
Indeed, I noted last week that there is likely to be some longevity to the enormous returns that AIB is enjoying, which should keep investor appetite warm. But stock prices can ebb and flow and much depends on how market expectations for official rates and the outlook for the fiscal finances evolves. Would the Government be prepared to continue to sell down stock in AIB even if the share price falls and a fresh placing has to be done at a lower price than a recent placing, breaking with tradition? Maybe – but it’s not a fait accompli. Any delay or wobble post-election could swiftly see further senior-level departures from the industry which I don’t think would be welcomed by investors.
But, if you have been reading this piece in full, you will know by now that I also believe it is imperative – and even more important – that the next Government has the courage to repeal the supertax of 89% on banker bonuses in excess of €20k. Whatever about the short-term vacuum that can manifest upon top-level executive departures, the supertax is arguably a massive impediment to recruiting and retaining the requisite talent below the executive layer. It also serves to inflate fixed costs, which is unhelpful in terms of cost responsiveness in the event of a changing environment.
So, hopefully the next Finance Minister (which could indeed be Chambers again) will stick his/her head above the parapet. There are strong defences for courageously – and early during the tenure of the next Government – moving to: i) erase the pay caps; and ii) remove the supertax. The sector has recovered and has paid back most of its dues. It’s time to move on and stop penalising those who have actually rebuilt organisations that stand in strong shape from a capitalisation and a financial performance perspective.
8. Boucher making the right soundings – the shareholder voice can help
On a final note, Richie Boucher, the former CEO of BOI (and current Chair of CRH) rowed in on the pay cap debate recently, articulating his views to the Business Post to the effect that shareholders “can’t just sit on the sideline” in the debate and noting that the EBA already has restrictive measures in place. I think Boucher is right. One should not underestimate the prospective influence of a coordinated international shareholder voice in this debate, particularly in policy circles in a country whose politicians are acutely aware of the importance of international investor sentiment in a broader inward investment context. The caps should go. But, I’ll go one step further – don’t just make it about the pay caps but petition to ensure that these credit institutions are ‘fit for the future’ in a wider context, with emphasis on incentives for high performance (and consequential improved cost flexibility over time). That starts with the removal of the supertax and the interrelated loosening of variable remuneration ceilings.
Footnotes
* The Business Post subsequently reported, in December 2022, that it received a copy of the report through a FOI request and that Korn Ferry had recommended that the pay caps be lifted and that senior executives be paid a maximum of up to €2.78m p.a.
** As an aside one could reasonably argue, in my view, that both AIB and BOI’s decisions to cap variable remuneration for staff at a level, on a blended average basis, that is considerably below the maximum of €20k per employee permitted pursuant to the above-referenced changes to the remuneration restrictions effected following the publication of the Department of Finance-led Retail Banking Review was a missed opportunity. While cost containment and/or political optic-related motivations may have underpinned the decisions to constrain (and despite the fact that BOI is still exercising considerable constraint at top executive level with the CEO and CFO paid far less than international peers working in similar-sized banks from a market capitalisation perspective) it has, arguably, created the perception that the whole debate is just about the top brass getting paid.
*** Notably, Francesca McDonagh received a salary in excess of the €500k cap owing to contractual arrangements entered into with the Minister for Finance upon her appointment. However, her basic level of pay still stood at a substantial discount to peer executives internationally.
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