Tuesday, January 13, 2009

Incentives Count-For Bankers Too?-3

"Incentives were horribly skewed in the financial sector, with workers reaping rich rewards for making money, but being only lightly penalized for losses, Mr. [Raghuram] Rajan argued. That encouraged financial firms to invest in complex products with potential big payoffs, which could on occasion fail spectacularly. ... In high school, he came across the work of British economist John Maynard Keynes, who became his intellectual hero. He was 'helping the world out of recession,' Mr. Rajan says of Lord Keynes. 'For a person growing up in a developing country, you sort of believe that there has to be a better way.' ... The [2005] Jackson Hole contretempts followed by a few months another set of attacks on Mr. Rajan for a study he co-wrote at the IMF that concluded foreign aid didn't help developing countries grow. ... Instead of heavy regulation, he says, the incentives of Wall Streeters need to change so that punishments for losing money are in line with rewards for earning it. At the start of 2008, he suggested that bonuses that financial workers make during boom times should be kept in escrow accounts for a period of time. If the firm experienced big losses later, those accounts would be drained", Justin Lahart at the WSJ, 2 January 2009.

I largely agree with Rajan, a University of Chicago professor. One problem: how to identify "boom times". I say, among other things, escrow all bonuses for three years. Incentives count!

6 comments:

Anonymous said...

how about this: if you bankrupt the firm you get fired, your bosses go to jail, and someone smarter at another firm continues to thrive. There is no such thing as "no lose". They have just made everyone but them the losers. The system now is like a doctor who has a patient with a tapeworm, who, when the patient starts ailing, kills him in an effort to save the tapeworm.

Independent Accountant said...

Edgar:
How about this: if you get aggregate bonuses of $5 million or more in a three-year period, then your company goes bust within three years of your having gotten the bonuses, you either: return the bonuses within 30 days of the bankruptcy or get exiled to China!

Anonymous said...

All good ideas... clawbacks rock!

One suggestion... take a bodyguard when strolling down Wall Street, Park Avenue and in Greenwich...

The knives will be out.

Anonymous said...

3 years is too short. It should be 5 years.

Usually 5 years gives you enough picture on the benefit/loss on what was done.

In 3 years it might not be visible.

Independent Accountant said...

Anonymous:
The problems might not show up in five years either. Where you draw the line is arbitrary.

Anonymous said...

execute
executives

simple