Lap dancers receive performance-related pay. Miserly and overenthusiastic customers aside, they get £20 per lap dance. The more beautiful, charming and determined the dancer, the more lap dances she will sell and the more she will earn. By allowing a woman with these qualities to work in his club, Peter Stringfellow puts her in the way of potentially large cashflows.
The same goes for investment bankers. Their roles vary but all can earn bonuses for their performance. For example, a foreign currency trader is typically paid a bonus equal to about 15 per cent of the net revenue he generates for the bank. By giving someone a job at an investment bank, its owners are putting him in the way of potentially large cashflows.
But here is one of the many differences between lap dancers and bankers: whereas Mr Stringfellow makes his lap dancers pay for the privilege of being put in the way of their bonuses, with a “house fee” of about £100 a night, investment bankers are paid to have the chance of earning bonuses in the millions, with base salaries ranging from roughly £50,000 to £300,000.
This is silly. Investment bankers, like lap dancers, should have to pay to go to work. If investment banks held auctions in which prospective employees bid for jobs by offering an annual fee, the banks’ owners – and all those others who nowadays concern themselves with the issue – could be confident that they were not overpaying their staff. Any excess pay would be competed away in the auction.
Not only would such auctions eliminate excess pay, but the best bankers would get the jobs. Being able to generate the most profits and, hence, the biggest bonuses, they would be willing to bid the most for the job. Of course, some high bidders would be overconfident rather than skillful, but they would soon be wiped out by their losses.
A call option gives its owner the right, but not the obligation, to buy something at a specified price (the “strike price”). If the going price (the “spot price”) is higher than the strike price, the option can be exercised at a profit. If the spot price is lower, then the option-holder need not exercise it and his loss is only what the option cost to buy.
An investment banker effectively holds a call option on his own performance. If a foreign currency trader does well, be it from skill or luck, and earns his bank £10m, he will receive a £1.5m bonus. If he does badly and loses the bank £10m, he does not have to cough up £1.5m. This is the notorious “trader’s option”.
As investment bankers know, options are valuable. There is no reason why someone should obtain one without paying for it, and certainly no reason why he should be paid to have one. The trader’s option should not be regulated out of existence. It should be priced in an open market.
Jamie Whyte is a senior fellow of the Cobden Centre.