Large bonuses have put banks and bankers into the doghouse despite their economic importance. But are banks paying more than they need for senior bankers? The relatively new field of Identity Economics, identified by Rachel Kranton and developed by her with Nobel laureate George Akerlof, suggests this may well be so.
When bank leaders defend the payment of large bonuses, they explain the need to pay well to retain talent. This suggests their economic model takes little account of the ideas that underlie Identity Economics, a recently identified facet of behavioural economics. As with behavioural economics, identity economics is built on reproducible, almost scientific, psychological experiments and anthropological observations rather than on the dismal, and probably mythical, homo economicus, who knows the price of everything but the value of nothing.
Classical economics reduces this type of decision-making to money. We pay people bonuses to encourage the results we target. Identity economics suggests that an important element is missing – the extent to which employees identify with their employer. This has been shown to be a valuable and influential component in real-life decision-making. And it explains why employees who identify with their organisation will cheerfully work for far less than they could obtain elsewhere.
This is where banks seem to be missing a trick. By treating high-performing individuals as assets to be bought and retained by money, banks make key players outsiders to the firm, in a relationship that is more commercial than emotional. If these people identified strongly with the firm, their loyalty would be a heavy counterweight against countervailing monetary inducements. Such a deep sense of identity is valuable even though it will never appear in the balance sheet. Created thoughtfully, it also brings considerable advantages when it comes to building a good reputation that is sustainable through bad times as well as good.
Arie de Geus, the Shell sage credited with creating the concept of 'the learning organisation', also spotted this. His seminal book 'The Living Company', is based on a 1983 study by Shell of long-lived large companies. Its conclusion was that the average life expectancy of a Fortune 500 company was as little as 40 to 50 years. Why? “...Companies die because their managers focus on the economic activity of producing goods and services, and they forget that their organisation's true nature is that of a community of humans.” His division of companies into 'puddle' and 'river' companies illustrated his point. 'Puddle' companies were 'managed primarily for profit' and, like a puddle, prone to dry up. In contrast, 'river' companies were 'organised around the purpose of perpetuating [themselves] as ongoing communit[ies]' and were far more likely to flow indefinitely into the future. His main differentiator between rivers and puddles centred on identity and the cohesion it brings to long-lived companies.
Identity economics is triply interesting to banks. It shows a route out of a life of constant opprobrium. It can help them to build sustainable shareholder value and a good reputation with solid foundations. And at the national level, it helps explain to hostile governments why it is so unwise to treat banks and bankers as a despised tribe – unless you want them to emigrate.