On July 8, the
European Parliament approved the world's strictest rules on bankers' bonuses. The rules apply to banks and investment firms, but not to hedge-fund managers.
The new rules ensure that bonuses provide less incentive for risky practices that increase executive compensation in the short term, at the expense of long term corporate financial stability.
Under the new regime, no more than 30% of bankers' bonuses can consist of up-front cash, and, in the case of very large bonuses, no more than 20% can be cash. More importantly, about 70% of total bonus value would be deferred for up to three years and would paid in a new class of security called " contingent capital".
Ordinarily, bonuses can be paid in the form of a note or "IOU" from the Company. Under the contingent capital scheme, however, in the event of financial difficulties, this debt is converted into equity, which, like stock, falls in value with declining company fortunes.
The new rules are likely to be formally adopted at a meeting of EU finance ministers this week, allowing them to come into effect at all banks operating in the European Union before this year's bonus season. American policy-makers eager to prevent future financial crises would be wise to look closely at these overseas developments.