Aligning incentives at gargantuan banks

News is swirling around on Wall Street about new incentive-based compensation rules being proposed for the nation’s largest banks.  The specifics of the proposed rules are not that interesting.  What is interesting is that the overarching strategy.  Aligning incentives with desired behaviors.  Genius!  Radically regulators are talking about awarding stock and deferred compensation to executives instead of cash.

My very first day of blog publishing, October 6, 2008 (see  https://jasonapollovoss.com/web2008/10/06/ethics-are-an-economic-issue/) I stated that executives at firms focused on too short a time horizon.  The reason is that financial rewards were being given for one year’s performance.  Never mind the fact that choices made to have a “great year” might ultimately bankrupt the company.  Unfortunately, once that cash was awarded, it couldn’t be asked for back from the folks who had made, ultimately, very, very bad choices.  To correct that myopic mentality I suggested changing how folks were compensated so that there was a more long-term focus.

Deferred compensation awards pay for performance this year, but the ultimate reward is not handed out until certain criteria are met in the future.  That clearly helps to align folks who are motivated in such a manner to the longer term interest of a business and its shareholders.  By awarding stock that is also locked up for several years, the same thing is accomplished.  That’s because stocks tend to rise for businesses that are performing well.  So again, important decision makers at such businesses are incentivized to think of the consequences of their choices beyond one year.  Excellent!

Regulators are talking about extending these compensation rules to only cover the largest, most gargantuan banks.  In the European Union the discussion is about much more stringent rules even than are being discussed in the United States.  I expect there to be a lot of peripheral whining about these rules.  Some banks, such as HSBC of the United Kingdom, are already threatening to move their headquarters to places where the rules are less stringent.  Why?  They are claiming that they are losing executives who want more money.

This is an issue that I have also addressed on the blog and my response to the above concerns on the part of affected banks is: good riddance.  If a company loses an employee who refuses to be compensated based on the long-term performance of the company, how can that be a bad thing?  Can these complaining businesses honestly say that they prefer to have myopic employees?  Such is the culture of big financial institutions that when the beer is taken away from the frat boys the party has seemingly ended.

Clearly I am an advocate of the newly proposed rules.

Jason