Tone from the top, skin in the game, the partnership model: my take on the LSE bank culture panel event

April 21, 2015

How to reform bank culture? A panel event on bank culture that I organized this past May 19th at the LSE took up this question by examining the practical solutions that banks are introducing (see photos here). The panel underscored the need for both cultural reform and structural measures. To some extent, the more measures the better. However, it is crucial to ensure that structural changes complement, and do not trivialize or contradict, cultural reform. Changing values and beliefs is a delicate matter, and brute force does as much harm as good, even when voters feel morally justified to use a bazooka.

The event, held at LSE’s Systemic Risk Center, chaired by Joel Shapiro (Oxford University) and supported by the Department of Management and the Principles for Responsible Investment initiative, built on a previous session that called into question the narrow emphasis on structure of the official reports on financial reform. But critique, that longtime favorite of academics, can only go so far, and for that reason in the latest panel I assembled bankers, academics and journalists with the explicit purpose of discussing solutions: what new practices are banks attempting to reform their culture? Which ones are working? Which are not? What do we learn from it all?

Tone from the top and other cultural changes

Appropriately, the panelists started by tracing banking scandals directly to culture, that is, to the values, norms and beliefs that define these banks. One panelist, Patricia Jackson (EY), reminded us about the infamous cabbages that managers of HBOS (a UK retail bank) placed on the desks of underperforming salespeople. The over-effectiveness of this technique, which encouraged the hard selling that ultimately derailed the bank, underscores an established sociological tenet: that internal standing, status, esteem and avoidance of social opprobrium mater as much –if not more- than incentives. Another example of symbols that matter is the bottles of champagne that Libor-rigging bankers received from colleagues for “taking one for the team.”

But if culture is the problem, it can also be the solution. Another panelist, Andre Spicer (Cass), mentioned the importance of the tone from the top, that is, a careful attention to the symbolic actions and messages sent from the top management and especially from bank CEOs. This approach is now very much in use by large banks such as Barclays to “turn around the supertanker.” (Another approach entails mimicking non-banks such as gyms and airlines, but this is only possible for more agile start-up banks).

But exclusive reliance on soft aspects such as norms and values can make financial reform fragile and transitory. Another panelist, Sarah Butcher (eFinancialCareers) reminded us that soul-searching and reform discussions were widespread as far back as 2002, following the dot-com bubble and the widespread perception that equity analysts were responsible for inflating it. Yet despite the banker contrition at the time, the dot-com bubble was followed by the subprime trouble. Memories are short, it seems. Repentance is quick to fade.

Skin in the game and other structural changes

Partly for this reason, panelists to agreed that cultural change needs to be accompanied by structural reforms, that is, by changes in incentives, limits to the banks, etc. Most such reforms are variations on  “greater skin in the game:” make bankers subject to the consequences of their actions. In this regard, one policy that according to panelist Yann Gindre (PRI), appears to be working, is deferred bonuses and compensation. This has reduced the turnover of bankers within the City: by getting employees to stay in the same organization they can be expected to take greater responsibility for their actions. Gindre also recommended making fines come out of the bonus pool rather than from the bank’s profits, as otherwise it is the shareholder that foots the bill.

An intriguing variation of “skin in the game” idea is to combine accountability with financial models, and specifically risk management tools. According to Patricia Jackson, regulators have traditionally faced a problem in managing the risk of the banks, which its opacity. But by pushing accountability for risk management down the line, Jackson hopes the heads of the various businesses will be more accountable.

Structural measures such as the above can help with the changes in values and attitudes pursued by cultural change programs. For instance, Butcher gave testimony to a change in attitudes in City institutions following the reduction in bonus sizes: there is now less interest in bonuses among job searchers in finance; banker arrogance –the attitude that financiers are the only hard working and competent people in the country– is partly gone. Butcher’s point illustrates the remarkable and often upside-down and counterintuitive manner in which cultural change operates: employees first change behavior, and then adjust their beliefs to stay consistent. Another panelist, Jo Geraghty (Culture Consultancy), emphasized the importance of integrating the espoused changes in culture within the structure of the organization.

Paying bankers for being good?

One key challenge in adopting structural measures is to avoid crowding out –if not simply destroying– positive cultural dynamics. Treating employees as dishonest immediately reduces their ethical commitment. For instance, banks are currently introducing cultural fit into reward and promotion measures, and developing metrics that measure culture. By explicitly paying more to the bankers that appear to behave in accordance to the espoused culture, the hope is that cultural change will be advanced.

Will this work? My concern (and one echoed by my informants in New York) is that explicitly accounting for values with pounds and dollars may create a confusion that can only be detrimental. First, it attempts a reduction of the domain of the moral into the economic, but by quantifying the monetary value of “good behavior” (e.g., ten percent of the bonus) it suggests that sufficiently high profits might compensate for obnoxious behavior such as hazing new recruits. Second, this approach may also come across as too controlling and manipulative: values and norms are and need to be broad because they call for judgment in specific circumstances, and by boiling them down to hard rules the judgment is eliminated. And third, it invites gaming and cynicism, potentially reinforcing the materialist message that the only point of work is the compensation.

Bring back the partnership model?

By contrast, culture and structure come together remarkably well in Sandy Pepper’s proposal to revisit the traditional institutions of the City of London, prior to the Big Bang of 1986. Before the arrival of the large Wall Street banks, the City was dominated by traditional merchant banks. While these were far from perfect –specifically, the diversity of their workforce was close to inexistent– careers in them were structured as tournaments, partners were collectively liable for losses, turnover was much lower, and employees arguably took greater responsibility for their actions. As Pepper says, these institutions contained pay and limited the traders’ tendency (given the visibility of their contribution to the bottom line) to become irresponsible hired guns.

While it’s tempting to dismiss such interest in the 1980s as romanticizing an inexistent golden age, I have been hearing similar interest in partnerships in my recent fieldwork in New York. And indeed, the organizations that come closest to it – hedge funds and private equity firms – have been the ones that performed best despite fears, well before the financial crisis, that their small size would make them vulnerable. Partnerships relied on status differences, so to the extent that these structures come back, we can expect the return of other retro aspects that come with them: formal dress codes at work, grander facilities, perks that reinforce hierarchical differences and signal esteem. In fact, it is interesting that retro fashion and formal wear appear to be back.

The partnership model will obviously not be viable for the large banks. The key will instead be to understand how to adopt elements of it, both symbolically and structurally, and combining it with technology. One possibility would be to argue for a complete reform of investment banks that shifts risk-taking into smaller hedge funds and private equity firms. The question then is whether capital markets need large global banks willing to risk capital in moments of crisis. This is in fact also Jamie Dimon (JP Morgan’s CEO) criticism of Dodd Frank, and indeed Dodd Frank has been cited as one of the reasons for the recent Treasury bill Flash Crash of 2014. Size, in other words, continues to be a  point of contention in discussions of financial reform.

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