If you were to organise a people’s initiative against being ripped off, you might be guaranteed some measure of success. The fact that the people allegedly doing the ripping off are highly-paid executives makes the issue all the more piquant.

The initiative in question was in Switzerland and culminated in a national referendum against ‘rip-off’ or ‘fat cat’ pay on 3 March. The referendum succeeded with 68% of voters voting for the measure on a 46% turnout. The issue is particularly close to the hearts of Swiss pension funds because it will compel them to engage with companies on the issue of pay. They would prefer a voluntary approach.

At the same time, the EU agreed on a legislative compromise to limit bankers’ bonuses to the level of annual salary, or twice that if agreed by shareholders.

It seems the issue of disproportionate pay has caught the public mood and the attention of politicians. What can be gleaned from these initiatives?

First, there is widespread and largely justified public sentiment against a financial system that allowed systemically important banking institutions to pile on risks unchecked and for the public to bail them out at huge cost. In Switzerland, this has been grouped, in the public’s mind, with the general issue of high executive pay.

Initiatives like this certainly make for good headlines and the public, having footed the bill for a range of institutions, has a right to some level of transparency on remuneration, particularly at banks. There is political justification for action to protect the public purse, even if the issues of banking bonuses and executive pay in general have been somewhat confused.

But any eventual EU measure is ripe for legal challenge and its mandate to intervene in individuals’ employment contracts is questionable. There is no doubt that banks will take up the cudgels against the eventual legislation.

Banks are, by nature, innovative institutions and will find ways around restrictions on their remuneration levels. They can already increase the level of bonus to double that of basic salary with shareholder approval under the current draft.

Is there a middle way between the right of banks and other companies to pay their staff what they want in a free market, and the right of the public to exercise some scrutiny over risk-taking institutions to protect the public purse against losses arising from future blow-ups?

The voluntary exercise of shareholder property rights should be at the root of any solution and there is already evidence that shareholders are engaging with banks on remuneration. Information rights on remuneration and bonus pools should be strengthened to give investors greater transparency on the risks that the bank proposes to reward.
By and large, approval of remuneration policies should be left to shareholders, and banking institutions should be allowed the freedom to pay certain individuals high salaries and bonuses commensurate with their skill and achievement.

Well-governed banks, with engaged owners will be crucial for Europe’s recovery. We certainly need a banking system that lends, funds and finances the things we need, and that takes the right kind of risks.

The right kind of leadership and internal culture, aided by institutional shareholders, will create the right kind of banking institutions.

Pre-emption is better than blunt legislative cure. Pension funds would do well, both individually and together, to be more active in corporate governance in the first place. Public scrutiny, on corporations and institutional investors, is here to stay.