When it comes to bonuses, the buck stops with Gordon

Performance pay is a tricky business. If you hired me as a hedge fund manager and paid me “2 and 20” – a 2 per cent management fee, plus 20 per cent of any gains – then I’d be tempted to take your money to a roulette table and put it all on black. If I won, I’d get to keep 20 per cent of the gains. If I lost – well, I would have been sure to deduct the management fee first.

If I were instead aiming to top a league table of investment managers, worse awaits. This time, instead of betting on black, perhaps I’d put the money on lucky number seven. If the rewards go to the most successful investment managers, then I need to go for broke – especially since “broke” is more likely to describe my investors than me.

All this is an exaggeration, of course, but discussions of bankers’ bonuses are haunted by visions of this kind of perverse “compensation” scheme. (Annoyingly, we use the word “compensation” as though bankers were being awarded damages after the trauma of executive life.) The popular view of bankers’ bonuses is simple enough: they never deserved to be paid millions anyway, and the fact that they seem to have blown up the world’s economy proves it.

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Tim Harford’s blog

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Tim, also known as the Undercover Economist, writes about the economics of everyday life.