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The Pay Quandary for Banks

Andrea Orcel’s signing-on package shows the scale of the pay pickle facing banks.

UBS paid $26 million to woo its investment bank head from Bank of America Merrill Lynch last year, making a mockery of so-called retention packages created to stop employees from jumping ship. True, Mr. Orcel received no new cash or shares for joining his Swiss rival: the award simply replaces three years’ worth of pay he forfeited for leaving Bank of America Merrill Lynch. And the award can still be clawed back. But it shows how aggressive behavior by just one bank can reinforce the industry’s pay problem.

The public relations impact is terrible. Here is an accident-prone bank paying to entice an outside executive who advised on the doomed carve-up of ABN Amro. Just a few months earlier, UBS had suffered a $2.3 billion rogue-trading loss. Later in 2012, the bank was hit with for a further $1.5 billion in fines to settle charges of rate manipulation.

But UBS’s action also shows the pointlessness of ammoth retention awards. Bank of America’s retainer simply didn’t work. As long as there is always one bank out there willing to bid high, existing pay structures will be hard to change.

UBS has come up with some interesting and welcome ways to reform pay. Executives will from now on be entitled to a bonus pool worth a maximum 2.5 percent of adjusted pretax profit. Employees will be paid in contingent capital, aligning stakeholder interests. And average deferral periods for bonuses are rising significantly for top earners.

Still, UBS is also trying to rebuild its franchise. And with a relatively strong capital position, it doubtless feels it can and indeed should pay whatever it takes to stay in the game. It has already unveiled a big shrinkage plan. UBS needs to excel in the investment banking businesses it is keeping.

Swiss citizens have granted shareholders binding votes on pay. The European Union is restricting variable pay to a maximum of two-and-a-half times base salaries.! Banks are slowly reducing compensation to revenue ratios. But the trend toward longer deferral periods means paying people to move firms will be more expensive. Orcel-style buyouts will persist.

Dominic Elliott is a columnist at Reuters Breakingviews. For more independent commentary and analysis, visit breakingviews.com.