Wall Street executive compensation

Robert Schiller began a look at executive compensation:

Last Wednesday, we presented our findings, “The Squam Lake Report: Fixing the Financial System” (Princeton University Press). Ben S. Bernanke, the chairman of theFederal Reserve, helped introduce the book at a conference at Columbia University. He said he agreed with the principle that “the stakeholders in financial firms — including shareholders, managers, creditors, and counterparties — must bear the costs of excessive risk-taking or poor business decisions, not the public.”

The issues facing us are complex. Let’s look at just one of them: the provisions in the Congressional bills on executive compensation.

Certainly, executive pay has grown enormously in recent decades, and there has been much suspicion that it contributed to the crisis. But it’s not the high level of executive salaries that helped cause the financial collapse. Efforts to reduce executive salaries have perversely created the wrong incentives. A 1993 law discouraging companies from paying their chief executives more than $1 million a year appears to have led to a de-emphasis of salaries and an increase in stock options.

So here is one of those epiphanies: Those stock options didn’t lower total compensation. And they probably encouraged C.E.O.’s to expose their companies to more risk, because options’ value grows as risk does. In fact, legislators’ misunderstanding of the law’s true incentives may have contributed to the severity of the crisis.

Barry Ritholz  differs:

The thought process behind this is that risky corporate activities should also become a risk to the firm’s executives. The case the Squam Lake economists make is that by holding back some of the executives’ personal assets, risky behavior becomes their problem, not just the taxpayers’. The hope is that “this will transform executives’ thinking about risks — and may help prevent another disaster.”

I sincerely doubt it. Similar disincentives were already in place — and they failed miserably.

At each and every one of the companies that went bust due to their excessively risky speculations — from AIG to Bear to Citi to Fannie Mae to Lehman to WAMU — every executive had huge amounts of stock, stock options, and future salaries at risk. Lehman’s Dick Fuld reputedly lost over $500 million dollars in stock value, and a few of Bear Stearns execs lost close to a $ 1 billion dollars each in asset value.

The mere threat of future losses has already proven insufficient to moderate behavior. Holding back $100s of 1000s of dollars — or even millions of dollars — is a meaningless inconvenience to the people whose net worth is measured $100s of millions or billions of dollars.

There are better alternatives.

While researching Bailout Nation, I did discover one group of Wall Street firms whose senior management took a very measured approach to managing risk. They managed to engage in risk taking and speculation in a fashion that was responsible, and avoided trouble.

The group? Wall Street partnerships.


Yves Smith points to the creativity of avoiding accountability through pay:

The big banks and broker dealers ALL went into the crisis badly undercapitalized. Why? Because the industry engaged in a variety of practices that allowed them to rely on what amounted to fictive capital. For instance, credit default swaps allowed them to hedge risk with undercapitalized counterparties like AIG and the monolines. When the hedges failed, the banks showed spectacular losses. Similarly, banks shifted assets into structured investment vehicles and other off balance sheet entities, but earned fees both for setting them up and providing services to them. When these entities started showing serious losses, the banks discovered they weren’t so “off balance sheet” and took losses.

But the focus on executive pay divers attention from the fact that pay levels across the big players is wildly out of line, given their ever-growing government guarantees. n a paper by Piergiorgio Alessandri and Haldane, “Banking on the State” (hat tip reader Scott), they describe how support to the financial system has ratcheted up in the wake of crises, which only makes it more attractive for banks to gamble.

So a banking industry that creates global crises is negative value added from a societal standpoint. It is purely extractive. Even though we have described its activities as looting (as in paying themselves so much that they bankrupt the business), the wider consequences are vastly worse than in textbook looting.

Robert Schiller first comment to the above post at Naked Capitalism describes a starting point rather bluntly:

That’s the way it is. The Bailout State is already starting to crack under the pressures of the Bailout, which is the real reason the system wants to move to “austerity” everywhere. The Bailout will soon be insufficient to keep the loot flowing, so the kleptocracy has to move from the bailout’s relatively indirect robbery to the direct robbery of stealing pensions and abdicating on services so more public money can be freed up to be stolen.

So one of the parts of the process should be to meet every hint of the fraudulent notion that any of this “compensation” looting is justified (and never let them get away with absolutely fraudulent words like “compensation” or “earn”), or that the “issues” are “complex”, with the clear truth:

These are parasites and criminals who produce nothing but needless cost.

Every cent they extract is being stolen.

Read more at http://www.nakedcapitalism.com/2010/06/why-is-no-one-willing-to-say-wall-street-is-overpaid.html#JQhSMrY6hfQeFQT2.99