The Securities and Investment Institute annual lecture How far does the industry compensation culture threaten its future? How to fix it?” was very timely considering the comments by the UK Prime Minister and no less the Archbishop of York this week. Both appear to be putting much of the blame for the financial crisis on the doorstep of dealing room stars. Although we can apportion some blame at banks and their dealers it is simplistic and not worthy of too much comment.

Tony Jackson, Financial Times commentator had his formative career working as a junior analyst at Wood Mackenzie a Scottish stockbroker of some esteem and highly respected within the securities market. Wood Mackenzie was a partnership where each partner effectively protected each other ensuring that no money was spent unless the company could afford it. This prudent approach also built long term security within the organisation where all employees were mutually interested in the overall success of the firm and its business. They enjoyed the success when created but a fair amount of belt tightening when times were tougher. A model to run any business!

There was no payment to anyone against unrealised profits unlike today with complex instruments and long term strategies creating paper profits but also undetected risks.

In the days of Wood Mackenzie there was no over lending against falling collateral values, no getting involved in complex financial instruments unless they were fully understood and risks evaluated. Conservative business management you might say and possibly not as sexy as today’s market. However, the business flourished and built long term loyalty of its employees who would not expose the firm to undue risks even if it was against personal interest.

Now it’s not possible today to recreate the Wood Mackenzie model but we can learn from how business used to be successful in a heavy risk laden industry. Compensation should be kept within the ability of the firm to pay and within a sensible structure with only remuneration and bonuses paid from realised profits. It sounds simple and it is. The greed of individuals and the aggression of financial institutions to compete above their ability create a highly risky and explosive situation. We can learn from the past and Wood Mackenzie and try and simulate a model that achieves the same objectives. The financial markets are built on competition and innovation with high rewards to individuals but this should not be at the expense of the firm or the industry as a whole.  

By Gary Wright, M.S.I.