| |||||||||||||||||||||||||
| |||||||||||||||||||||||||
 Suddenly we're inundated with schemes for regulating compensation, notably bonuses, particularly out of a reform-minded Washington, as Bill McConnell describes in the new issue of The Deal. Unlike the last downturn, the focus of these plans seems to be Wall Street, not corporate CEOs. Meanwhile, Kenneth Klee over at Corporate Dealmaker highlights a recent plan from Morris Goldstein of the Peterson Institute for International Economics, who proposes reducing capital requirements of financial firms:a) deemed to be systemic risks b) in exchange for agreeing to build compensation systems along government-approved lines.
This is certainly a bold scheme in that it puts to a real-world test the hypothesis that compensation structures were at the heart of our current woes. It is, to say the least, a gamble to reduce capital on the belief that more prudential comp practices will spawn more prudential management.
But let the discussion begin. I'm not going to debate various proposals to regulate compensation as much as point out some potential unintended consequences. I'll start with Goldstein's plan, but the purpose is really to consider broader complexities and issues in the great comp debate that's developing. 1. How do you define a firm that poses systemic risk? Clearly, we missed a ton of systemic risk this time around. But how do we know when a relatively obscure hedge fund, say, happens to be camped on an economic jugular? This is the Penn Square bank problem -- named for the tiny Oklahoma City shopping center bank that helped bring down mighty Continental Illinois in the '80s. How much systemic risk involves not individual firms, but combinations of networked firms? How do we reach such a decision without a comprehensive system of regulation and risk monitoring in the first place? How do we discriminate between firms without edging into political decisions, thus revisiting the Fannie Mae and Freddie Mac debacle, which also involved reducing capital to support noneconomic ends. And how do we do that in a globalized, deeply complex, fast-moving financial system without dampening performance? 2. How do we insure that there's not regulatory arbitrage without trying to regulate everything (see above)? Why wouldn't talented individuals move from firms that limit comp to those that don't? Don't we then create a pooling of risk in places we can't easily supervise? Do we eliminate current regulatory distinctions between private and public? Can we constitutionally regulate matters such as pay at private firms? And, again, how do we insure that risk-taking doesn't just move offshore, leaving us with the drag of large, marginally profitable institutions? 3. How certain are we that shareholders in financial firms will hammer down bonuses? This is the heart of the argument for say-on-pay. The trouble here is that, at least in the wider corporate world, shareholder empowerment has so far had very little effect on CEO and senior management comp. And there's been very little shareholder activism on Wall Street. Say a shareholder in Goldman, Sachs & Co. gets a chance to hire a trader he thinks can make the firm $100 million for a $10 million bonus. Would that shareholder say no? Except in a crisis, shareholders generally only want results; they don't want to (or can't) micromanage bonuses or even bonus levels, and they're very willing to spend to make. (I would make the case that at times shareholder desires actually drive compensation.) The federal government now finds itself in this uncomfortable position, with one of the interesting litmus tests being, yes, Goldman. The government needs to get its money back. But if Treasury or the Federal Reserve crack down on bonuses, revenue generators flee, the stock price falls in line with profits, and that payback is going to be put off. That's not a moral critique of high pay, just a reality. And again, the only way to really slay the high-pay dragon, is to regulate everything -- Wall Street, corporations, hedge funds, private equity. 4. How do you regulate the desire to get rich? After all, that's what we're talking about here. A lot of reasonably bright people come out of school every year drawn not to Wall Street or buyouts or even mighty Acme Inc. They're attracted to high pay and the lifestyle that goes with it. To stifle that desire -- call it greed -- requires us to block every avenue and every opportunity. The real question is whether that level of omnipresent regulation required is worth it and is productive of greater economic good. And if we're so concerned about reducing high pay across the board, why not use the tax system to deal with it? (The answer: We're allergic to taxation.) That's not to say there aren't intelligent proposals on pay, particularly when it comes to structuring compensation to lengthen time horizons -- something, by the way, Goldman's partnership system excels at. But the compensation debate often obscures more difficult questions of regulation, particularly when it comes to finance. How important is a competitive financial sector to the real economy? How hot should such a system run, and how much leverage should be permitted? What's the role of speculation -- and how can we encourage longer-term investment? How do we balance competitiveness with risk? How (to return to Goldstein) do we define systemic risk in a networked world? And by the way, I also believe that as long as the federal government has a large stake in financial firms it can do any damn thing it wants, including killing bonuses. But as a taxpayer, it would be nice to see those stakes worth something someday. It's a people business after all. - Robert Teitelman Robert Teitelman is editor in chief of The Deal. CategoriesComments
From: Ted Tanna,
Tell me how to become active to the Wall Street Giants? Say a shareholder in Goldman, Sachs & Co. gets a chance to hire a trader he thinks can make the firm $100 million for a $10 million bonus. Would that shareholder say no? Except in a crisis, shareholders generally only want results; Does lack of results,ie;
Posted on:
November 3, 2008 5:58 PM
 Deal Video
    Community
 Elsewhere on The Deal.comDealwatch
The Deal MagazineCorporate Dealmaker
The Deal VideoCategories
Blog roll
Archives
| |||||||||||||||||||||||||
|
|
|
|
|
©Copyright 2009, The Deal, LLC. All rights reserved. Please send all technical questions, comments or concerns to the Webmaster.
A connected issue is how big the financial sector issue should really be.
http://epicureandealmaker.blogspot.com/2008/10/ring-ring-its-cluephone-for-you.html