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A Better Way to Fix Bankers’ Pay
Here is a thoughtful article discussing the benefits of linking risk, performance, and compensation. In order to prevent banking collapses in the future there needs to be goal congruence between the managers and the companies so that managers are not pursuing goals to earn higher pay that turn out to be bad for the firm. Of course this should have always been a goal but it seems that things got out of whack and that, at least partially, is why the financial system experienced such chaos in the last year.
The implicit response seems to be that they were distracted by their greed. According to this view, these villains exploited the financial system for their own gargantuan end-of-year bonuses, got bailed out, and have every reason to do it again. Given this inherent moral hazard, it’s no wonder that so many political leaders in the U.S., Europe, and elsewhere are eager to rein in bankers’ compensation.
The moral hazard is a real concern. But the plans to limit compensation will not work, because they do not address the core problem: the disconnect among bank capital, risks (borne by both banks and society), and compensation structures (particularly the way traders are paid). If the financial leadership of the Group of 20 (G-20) can follow a “triangle principle” — building a tight regulatory connection among those three factors, making them interdependent at a granular level — they will get closer to mitigating the moral hazard. And they won’t have to regulate bonuses directly.
A Better Way to Fix Bankers’ Pay. Instead of bashing bonuses, let’s put in place the incentives we need: linking compensation to risk and capital. Shumeet Banerji. strategy+business. November 2, 2009.
