Stuart Fraser: Policy chairman at the City of London Corporation

As the jobless toll rises and families tighten their belts, it is not surprising that people are looking for somewhere to lay the blame. City bankers — and particularly the bonus culture — have often been the target of choice.

It is true that inappropriate remuneration structures contributed to the financial crisis, by encouraging traders to take excessive risks, but scrapping bonuses is not the solution. Instead, directors and shareholders must design pay schemes that properly manage risk and reward good performance.

First, we must separate the valid debate about bonuses from general mudslinging against City pay. Many of the gripes we hear about the bonus culture are actually about how much financiers are paid. Yet the real debate about bonuses has little to do with how much employees are paid. Rather, it is about how their pay is structured to create incentives.

As the Financial Services Authority pointed out in October in its letter to City chief executives, there are good bonus schemes and bad bonus schemes. The principles of healthy bonus schemes are fairly clear. The International Institute of Finance, for example, suggests that “compensation incentives should be based on performance and be aligned with shareholder interests and long-term, firm-wide profitability, taking into account overall risk and the cost of capital”. That sentence is worth printing, letter for letter, on the back of every City business card. We need to learn that bad bonus schemes encourage employees to take excessive risks and do not link rewards closely enough to performance. Some of this has been going on. those who did it are paying a heavy price and taxpayers are bailing them out of their mistakes.

Yet remuneration is only one element of a firm's risk management toolkit. Bonus reform must be seen as part of the wider restructuring of business and risk management models that will result from this financial crisis. To focus entirely on bonuses would be to miss the much bigger lesson we should digest — that shareholders and boards need to be better at scrutinising the risks their staff take. So the answer lies in better corporate governance, not regulation. No amount of box-ticking can replace common sense and intelligence.

The obvious advantage of paying performance-related bonuses is that the interests of employees are aligned with the interests of the shareholders. There is a counter-cyclical benefit, too: in a downturn, cutting bonuses allows employers to reduce their wage bills without making redundancies. In the longer run, London's competitiveness depends on its ability to attract top talent. Employers must be able to reward top performers to compete truly in the global skills market.

I am not arguing that the City should do nothing about remuneration structures — anyone who takes risks on behalf of others must be made keenly aware of their responsibilities — but the bonus culture has some clear benefits that we must not lose sight of.

Sir Andrew Likierman: Dean of London Business School and Professor of Management Practice

Of all the controversies spawned by the financial crisis, one subject above all generates near-universal dissatisfaction: executive remuneration.

Flawed or distorted incentives are held responsible for spectacular management failings and miserable results. Remuneration committees are accused of producing a system that provides executives with juicy payouts just as profits are turning down.

All too rarely does one find a true alignment between a company's present and prospective performance and the compensation received by its top executives. Just as hard to find are remuneration practices that provide incentives to management to act in a company's long-term interests.

Our present remuneration practices are partly based on a false premise: they are focused principally on rewarding past performance rather than shaping future performance. And, as any investor will tell you, past performance is not necessarily a guide for the future. By focusing reward on the past, a crucial element of performance is being ignored — just how well placed is the organisation to deliver sustainable returns? To make sure that greater emphasis is placed on investment for the future and to act as a counterweight to short-termism and to pressures from the reporting treadmill, I suggest that a significant proportion of senior executives' annual bonus — between 25 per cent and 50 per cent — be based on criteria linked to the ability of the organisation to deliver sustainable performance in the future.

The criteria used should tie individual executive bonuses to the company's strategy execution through a combination of non-financial measures (eg, progress on innovation or market share, both compared to plan) and judgments (eg, diversification strategy or progress on talent management).

The basis on which judgments are made should be set out in a statement of principles, coupled with the basis used to set targets and published in the annual report. This approach has the merit of combining rewards for past performance with forward-looking measures. It would deliver fewer perverse incentives than present short-term, numerical assessments linking remuneration to stock market performance. It would be flexible, in allowing remuneration committees to set annual milestones and gather evidence to frame their judgments. It would also deliver the huge benefit of encouraging boards of directors and their remuneration committees to be more explicit and informative about their strategies and how they expect management to execute.

Shareholders may be nervous about substituting hard, numerical criteria with subjective, unquantifiable principles. But the opposite of financial is non-financial, not woolly. With robust and clear criteria and with retrospective assessment, it would be easy to put such worries to rest. In any case, such is the dissatisfaction with remuneration practices, the onus is surely not on proponents of change to prove that they have conceived the perfect system but on defenders of the status quo to justify its retention.

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