Nomura case sounds warning bells

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'HR people and business people should be aware of this because it's a big vulnerability,' says consultant and banking compensation expert Steven Brooks. 'Discretionary bonuses have sometimes been interpreted as bonuses to be fixed at whim. In future, companies are going to have to have an explicit process leading to bonus allocation. They need to show that performance is being properly reviewed and to leave some kind of paper trail covering themselves and showing how they arrived at their decision.'

Nomura came a cropper over its proprietary trader, Steven Clark. A former heavy hitter, Clark was summarily dismissed in 1997, without a bonus. Clark claimed that he was entitled to a bonus because he had produced 6.47m in profits during the period preceding his dismissal. But his contract gave Nomura discretion over the bonus awarded, and the bank argued that it was merely exercising this discretion. However, Justice Burton deemed Nomura 'perverse and irrational', and ordered it to pay up.

Brooks speaks for many HR professionals when he says that, while discretionary bonuses are unlikely to disappear in the wake of the ruling, they must become substantially more transparent.

'It is entirely legitimate and necessary to discriminate in the way that you pay,' says the head of HR in one investment bank. 'You just have to be able to explain why. Managers who think that they can exercise discretion arbitrarily will have to think again. People are going to have to be a lot clearer about how they manage performance. The objectives against which people are being measured will have to be clearly articulated, on both an individual and a departmental level. This is a challenge, but it is a much needed challenge. There is no situation in which having uncertain objectives is good business practice.'

Employees themselves are likely to benefit from more openness. Expectations of discretionary bonuses have in the past been dependent on trust. Given the proportion of salaries comprised of bonuses, this is perhaps surprising. 'Here you have a group of people who are quite litigious - especially in the US - and yet they accept a contractual entitlement to only one tenth of what they expect to be paid,' says Brooks.

Andrew Granger, head of employment law at Taylor Joynson Garrett, says employers must ensure that the circumstances in which might refuse to pay a discretionary bonus are clearly described in the contract of employment.

Such provisions will not be easy to draft, he adds, and can easily become double-edged swords. 'By attempting to define non-payment circumstances in detail, employers might make it easier for employees to challenge [them] by alleging that none of the specific circumstances provided for in the contract apply to their particular case,' he says.

However, one thing they can do, says Granger, is state expressly that discretionary bonuses will not normally be paid to employees who have resigned or who are under notice of dismissal for reasons connected with their conduct or performance.

Such transparency may bring simpler pay structures. But it is unclear how the complex determinants of bonuses can actually be codified and made less subjective.

'Only a small proportion of the bonus is directly related to performance,' says a former bank HR director. 'You are not only paying for present performance, but you are also paying to retain staff. Unless you are completely incompetent, there is an element of a bonus that is expected and all but guaranteed, there is an element that is related to performance, and there is an element that is related to your value in the market. It is not easy to put all of these elements together into a formula.'

The challenge is to create pay structures that are transparent, but still permit banks to make variations in line with market conditions. What's more, says John Leonard, banking analyst at Schroder Salomon Smith Barney, the new structures should be in place before the next economic downturn. 'The times when good management stands out are when revenues are slow,' he says.