Behavioral Finance

Bonus payments are ahead in many banks. This year distributing bonuses might be a particularly difficult task for top management in banks with various business segments such as wealth management and investment banking under one roof. Let us assume that investment bankers have lost a lot of money in the subprime crisis and that their division consequently generated losses whereas the bankers in the wealth management division have created big profits.

Bank`s top management has to give a clear signal that it is well positioned to solve the crisis caused by the investment bankers. "Giving clear signal" means a.o. measures to cut bonuses. What happens if you substantially cut the bonus of a New York or London based investment banker (even if he was part of a team that has created huge losses)? - he probably leaves. If the bank sticks to both wealth management and investment banking, allocating bonuses to the various divisions becomes more a political than a reward oriented task.

What`s the sense of organizational structures which incorporate completely different businesses under one roof?

Organizational research gives essentially technological reasons for its existence. Examples are information processing, supervision, task assignment and the coordination of interactions across activities.

The activities between wealth management and investment banking might be rather minor..

Organizational structures should be developed in order to maximize the organization`s effectiveness and ressource allocation. Ressources should mainly be allocated to divisions with exzellent risk adjusted returns and the biggest growth projects. Within a bank with wealth management and investment banking this would most likely be the wealth management division.

In times of bonus allocation, as mentioned above, top management might realize that structures could become the battle ground for political contest. The structural position of management plays an important role in such political contest. As long as the bank intends to keep its loss making investment banking business, the management of this division will have a quite strong negotiation power. They will argue that the market for investment bankers is very efficient and that people will leave if they do not get a substantial bonus.

That is no meritocracy anymore! Such problems could be overcome with structures which make a clear separation between investment banking and the rest of the businesses. "Clear" includes also a (partial) separation of shareholders. Investors who like investment banking type of businesses might have a completely different risk profile than investors who choose to invest in long-term oriented wealth management type of businesses.

City bonuses: after the long feast, time for some famine, Guardian unlimited, Dec. 2, 2007