Hats off to Singapore!

September 24, 2015, Chennai

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It is common knowledge that Singapore, the island city-state off the southern tip of the Malaysian peninsula, is the envy of the world for its democratic government, bureaucratic efficiency, rule of law, and economic progress. It encompasses all of 710 square kilometers and that makes it one of the smallest nations in the world.

With a population of about 5 million largely consisting of ethnic Chinese, Malays, and Indians, Singapore boasts being the 5th richest country in the world in terms of GDP (Gross Domestic Product) per capita.  It was a British trading post and a colony of Britain until it became an independent republic in 1963. The government strives for and achieves ethnic harmony by accommodating the culture of different ethnic groups. Like Switzerland, it also seeks to have linguistic harmony by declaring English, Chinese, Malay, and Thamizh as the official languages.  Singapore does not have much natural resources but it makes up that deficiency in the areas of trade, technology, and tourism.

Singapore                       Mariyamman Temple

    Singapore’s Financial Center                                    Mariyamman Temple

The infrastructure in Singapore is exemplary and their adherence to the rule of law in minute detail is proverbial. Singapore attained a little “notoriety” a few years ago when they enforced a “no litter” rule by punishing (with caning) a wayward American, who spit gum in the street. The event caused consternation in some western nations (which had similar laws in their books but were lax in administering them) over such crude punishment but it also raised Singapore’s profile over application of laws to all its residents. So far so good!

But the kudos (as the title of this article indicates) comes as a result of the government’s innovative and much lauded approach to financial reform.  Let us examine what happened in the recent past. The whole world has been suffering for the past two years from a financial meltdown in the stock markets that was caused by the collapse of financial derivative products issued by big banks, investment houses, and insurance companies. Excessive greed, interest rate fluctuations, and borrowing beyond one’s abilities by individuals and organizations produced a debacle in the stock market, forcing governments to bail out banks and insurance companies at enormous cost to taxpayers. In addition, the very same outfits that caused the disaster also started a chain reaction of layoffs resulting in high unemployment and recession all around.

To add fuel to the fire the bank executives who caused the disaster were taking home huge sums as pay, bonus, and stock options based on their contract and risk-laden activity. Not only in the financial sector but even in other businesses, the CEOs who dragged their company stock value in the negative territory for years have walked away with multi-million dollar packages upon their exit. It is a case of raking money when you perform well and raking money when you prove to be a disaster as well. In free market capitalism it is necessary to take risk in order to produce wealth and that risk has to be rewarded appropriately. But the reward system has not been in proportion to the result for several years. I have been advocating that if a stock price keeps going up (an indication of a business making handsome profits) the management has to be rewarded handsomely but if the stock price keeps going down the management responsible for that should give back the rewards earned earlier, and take pay cuts until the sit
uation is reversed. No, it has not been happening that way. It is all “heads I win, tails you lose” for the management.

Breathe a sigh of relief because Singapore is coming to the rescue of the ordinary investors. Singapore’s Temasek Holdings Pte. Ltd., is a state-owned investment firm with a portfolio valued at over $100 billion that holds stakes in some of Singapore’s biggest companies. It also invests in companies outside Singapore, real estate, and hedge funds. This firm compensates their employees reasonably well that includes cash bonus payments and deferred incentives. A key part of the bonus plan links the payments to a feature called “wealth addition”, a measure of the company’s return on investment which factors in its risk-adjusted cost of capital. At Temasek everyone has a bonus bank tied to wealth addition. If the wealth goes up the employee’s bonus bank receives inflow of money which then funds the deferred bonus. The bonus thus earned does not vest for at least 3 years and sometimes it takes up to 12 years. Not that much different from other plans operating elsewhere. Here is the important part. When Temasek los
es money in a given year (i.e., negative wealth addition), money flows out of the bonus bank. That means it is difficult for the employees to enjoy previously awarded bonuses. This is known as clawback, i.e., give back what was given to you earlier.

In the year ended March 31, 2009, Temasek’s portfolio fell by 30% and its profits fell by 67%. Its “wealth added” was a negative $48 billion. This meant everyone’s bonus bank took a corresponding hit. In its annual report Temasek says that its pay plan is marked by the principle of sharing gains and pains “alongside our shareholder”—in this case it is the Singapore government and indirectly the citizens. This is entirely consistent with standards for banking compensation recommended by the Financial Stability Board and adopted by the Group of 20 industrial and developing nations last year. It is time that this type of compensation system is adopted by all companies worldwide. In the mean time, Singapore has to be commended for setting a model for the rest of the world with such an equitable approach to returns and rewards.