Bank bonuses – the rational behaviour of the RBS directors

Robert Peston reported last night that the directors of the Royal Bank of Scotland are threatening to resign en masse if they are not permitted to pay bonuses to the investment banking arm of RBS, as has been threatened by government statements earlier this year. What is surprising is that this has been viewed with shock and astonishment. It was always misleading to suggest that bonuses could be dealt with by societal pressures – particularly given that while RBS is largely owned by the taxpayer (through a holding company) it remains a separate entity with a separate board of directors. That board is bound to act in accordance with company law as codified in relation to directors duties in the Companies ACt 2006. The duties of directors are as follows:

Under section 172 of the Act the directors "must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to—
(a) the likely consequences of any decision in the long term,
(b) the interests of the company’s employees,

(c) the need to foster the company’s business relationships with suppliers, customers and others,
(d) the impact of the company’s operations on the community and the environment,
(e) the desirability of the company maintaining a reputation for high standards of business conduct, and
(f) the need to act fairly as between members of the company."

Now, while this includes reference to consideration of the impact on the community and the environment and the long term impact on the business among other contradictory factors the key is that the company is to act in the interests of the members "as a whole" to "promote the success of the company". Here, RBS has a very successful investment banking arm, contributing substantially to the future success of the company (and consequently to the chances of speedy repayment of the state investment in the bank) . Indeed, Peston suggests that it contributes about half the wealth of RBS. Is the success of RBS in this sector at the moment down to the change in the market (with Lehman and others vanishing)? Or is it – at least in part – attributable to having people that are good at their jobs working in this area? The board of directors seem to be of the view that it is the latter. Their fear is that if bonuses are not paid these people will leave to join the investment banks or banking arms of others. There is then a fear that they will struggle to replace the very talented. The consequence is that this would be detrimental to the long term interests of the company and in the short to medium term would not promote the success of the company, the one thing they are legally bound to ensure.

Where the interests of some shareholders conflict with the interests of the company as a whole the interests of the company take priority,

Given this what can the directors do? They are potentially liable in damages for detrimental impact on the business.This is a personal liability. As a director you might not fancy facing having to pay out millions of pounds to shareholders from your pocket. Particularly when an action by any one minority shareholder (ie every individual excepting the state) can be raised under s 994 of the Companies Act if the conduct of the company is unfairly prejudicial to that shareholder. While examples of unfairly prejudicial conduct usually involve small companies where one shareholder is frozen out of management or blocked from receiving dividends there are cases where a minority shareholder successfully sues for unfairly prejudicial conduct where the directors are breaching their fiduciary duties.

When faced with this advice, and the potential fettering of their ability to manage the company they have been appointed to manage – a director has two options. Either to breach the duty and incur liability – uncertain of the potential limits; or resign.

The threat to resign is not an idle one. It is completely rational behaviour by people that would like to avoid personal insolvency. The risk that must be factored into the equation is that every potential director with experience of the sector will have exactly the same advice. The risk is not personal to these directors. It is a direct consequence of the legal framework against which they are operating. It is therefore not enough to suggest that the government call the directors’ bluff as Vince Cable has done (and has been praised in a variety of blog posts from many people I respect this morning such as Caron , the Millennium Elephant, Stephen, Charlotte Gore).

If the government wants to change bonus culture – and to deal properly with their concerns over the RBS bonus situation – they need to legislate. And that will impact on every bank – with who knows what potential consequences to the financial sector in the UK?

ETA (2 pm) I see peninsulawyer takes a similar view. The law is pretty clear here. Political posturing wins headlines, but doesn’t deal with the underlying problems.

About loveandgarbage

I watch the telly and read when not doing law stuff and plugging my decade and a half old unwatched Edinburgh fringe show.
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1 Response to Bank bonuses – the rational behaviour of the RBS directors

  1. Anonymous says:

    Bankers’ Bonuses
    I take your point. As ever your knowledge of the law is spot on and I think that you are stating the under-pinning fiduciary duty very well (at least for this layman). However is the fiduciary duty as absolute as you suggest? Just say a business chooses to employ sweat-shop labour, paying minimal wages, in unsafe factories in a country in the developing world. That may well produce the highest return possible for its “members” (i.e. share-holders). Does that mean that the whole board has to resign if the majority shareholder decides that from now on they should de-invest from that supplier and use suppliers paying internationally accepted rates of pay and providing far safer working conditions? I don’t think so. Because the directors could say that they are only giving due regard to “the company maintaining a reputation for high standards in business conduct”. Similarly with the bonuses. What about the “likely consequences in the long term”? Many economists, not only those on the left, believe that the bonus culture encouraged suicidally high risk taking. This was because bankers stood to gain massive bonuses in the short term, rather than being rewarded in the long term, as previously, through the increased value of shares they held in the company by which they were employed. So the shareholders took all the real financial risk (so did the ordinary citizen though we did not know it at the time) whilst the fund managers walked away as millionaires whatever happened in the “long term”. None of this detracts from your argument that their decision would be easier if a change was made to the law. Until then though any attempt to “sell” these bonuses to the public will fail We’re not interested in the £6 billion that RBS supposedly made in the last year (that could well turn out to be a loss in the long term). It’s the £850 billion that we have forked out to save these bankers jobs that they choose to ignore at their peril. I’m with Vince Cable, let them walk if they want to.

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