Ok - so we’d agreed that the Epicurean Dealmaker could have the last James Bond-themed word in this spat. But it would be remiss not to draw readers’ attention to the response of Larry Summers to Martin Wolf’s call for regulation of outsize banking pay packets.
The devastation of repeated banking crises, argued Wolf, justifies the spectre of official intervention. The current system of paying huge bonuses on the basis of short-term performance creates incentives to disguise risk taking as value creation. Pay should be better aligned to the realities of the business - made in restricted stock redeemable over a run of years.
In at least two respects, the argument is flawed, retorts Summers, writing in response to the piece on the FT’s Economists’ Forum:
First, he asserts that the change he suggests is not one that any one bank can make unilaterally. Why not? If he is serious about caring only about the structure of compensation not the level, then a bank that wants to change to a system that better aligns incentives can do this and can provide a level of compensation sufficient to compensate for the deferral element. Presumably if the whole industry is forced to make this change something similar will happen. Second, there is a distinction under recognized by Martin between compensating people based on annual profits and compensating them based on stock market performance which recognizes forward looking risks. There is a reason why trading houses and especially those with a reputation for risk taking have much lower p/e’s than other institutions. Managers compensated in stock or options have strong incentives to run their firms in ways where they are credibly around for a long time. Third, there are all kinds of technical problems–what about managers ability to hedge their stock? What about their excess incentive to sell out their institution so as to realize gains early?
The first point relates to the possibility of an exodus of top talent from the bank which unilaterally moves to reduce the cash portion of bonuses. Of course, in bad times this happens regardless, such as at UBS which has upped the portion of bonuses paid in stock (although it may allow bankers to sell their shares more quickly than previously, as soon as after one year, to help keep the peace.)
Summers concludes:
There is the meta question of whether if public humiliation and a foreshortened tenure of earning 30 million a year does not deter behavior Martin doesnt like why will deferred stock? I think these are all serious problems but it is easier to be critical than constructive. I am inclined to think that leaving stock prices out of it and causing traders’ compensation to be more subject to clawback after bad years may have merit.
Just when TED thought he might have an ally. Clawback was the subject of another contentious opinion piece two weeks ago penned by Raghuram Rajan, suggested that portions of compensation be held in escrow to be paid out (or not) over time.
Clawback though seems as problematic logistically, if not more so, than stock. Much easier to give out shares which may be worth less down the road, than to hand out goodies only to confiscate them for bad behaviour. The reason this might be appealing to some is that presumably such a mechanism might be better able to target the retribution bonus-wise on those whose investments have run adrift. Around the City, bankers are fuming that a four-man team buried somewhere in the fixed-income department has ruined their party.
But the losses formed around the four-man team were out of proportion with its size (as were their earnings in the good times), and turned out to be big enough to put a serious dent in a bank’s standing and balance sheet. Which makes it a firm-wide problem, shareholders included.
Felix Salmon previously suggested that the way to kick-start clawback would be for Goldman to be the first to move, only to be informed by his readers that it already had. Goldman apparently claws back at the group or strategy level, rather than at the individual trader level, to reserve against long-term negative outcomes even when there’s an immediate profit. And everyone wants to work there. Especially at the moment.
