Sunday, October 05, 2008

Executive Comp

There's a lot of talk about limiting executive pay. One compensation consultant noted:
Alan Johnson, managing director of pay consultancy Johnson Associates Inc., blames unrealistic performance targets for much of the risky behavior. He says executives of some financial firms he advised had to produce a return on equity of 20% to earn their full annual bonuses. A more realistic goal might have been around 15%, he says.
Clearly, that's a recipe for disaster, because banking is about putting on assets that are often front loaded in fees, and often have average lives of 7 years. I would think a better compensation would be to give these guys options that mature in 5 to 10 years, or some function of net income, including extraordinary items, over such a period.

Giving a financial executive a bonus based on this year's ROE, seems like an incredibly dumb incentive, moral hazard of the first order. They did mention they are trying to make executives hold stock for 2 years after leaving the firm. A good first step.


jsalvati said...

Are there corporate governance problems that make improvements in CEO payment schemes slow?

J said...

The pressure to perform in short time is not unique to the banking industry. The same could be said of the auto industry, the shipbuilding industry, even the retail industry. I believe Japanese and Swiss banks operate differently, yet their longterm results are not better than the American ones.