Simon Johnson neatly characterizes the competing views of the behavior of top management at the largest banks:
One view of executives at our largest banks in the run-up to the crisis of 2008 is that they were hapless fools. Not aware of how financial innovation had created toxic products and made the system fundamentally unstable, they blithely piled on more debt and inadvertently took on greater risks.
The alternative view is that these people were more knaves than fools. They understood to a large degree what they and their firms were doing, and they kept at it up to the last minute – and in some cases beyond – because of the incentives they faced.
The emphasis is mine. He goes on to describe the conclusions of a recent paper in which the authors found support for the latter view rather than the former. In very terse summary over the period of 2000 to 2008 the CEOs of the top 14 financial institutions netted $650 million through sales of their own companies’ stock while the market caps of these stocks declined from $74 trillion to $47 trillion over the same period. That’s exclusive of wages. The authors found that:
CEOs are 30 times more likely to be involved in a sell trade compared to an open market buy trade. The ratio of the dollar value of their sells to buys is even more lop-sided. The dollar value of sales of stock by bank CEOs of their own bank’s stock is about 100 times the dollar value of open market buys of stock of their own bank’s stock.
Their proposal is that sales of stock by top management be prohibited until two years (or more) after the end of their tenure.
Over the period of the past 40 years there has been something of a cyclic trend for large companies to give their top management part of their compensation in the form of stock. When the stock is unrestricted as is generally the case, the incentive of the manager is like anybody else’s: buy low, sell high. Or in the case of banking stocks, sell high and don’t buy at all. The incentive is for short term gains potentially at the expense of the health of the company—a perverse one.
Why do stockholders put up with this? Over the same 40 years an increasing amount of stock ownership has been on the part of large institutional investors, particularly pension funds. These funds have maintained unrealistically high assumptions about the returns they can expect which are coming home to roost.
The key problem here is that these funds have much the same incentives for poor stewardship as the managers of the top 14 financial insitutions: take the money and run. The problem with being unconcerned about the long term fate of a company whether it’s a bank or an automobile manufacturer is that the long term eventually comes. Here, today, the future is now and our growth prospects don’t look nearly as rosy as they did just a few years ago.
IMO we need more managers whose motivation is to build and run companies than those who want to make a big pot of money and retire to Majorca. The incentives are aligned the wrong way. However, I don’t think that the prescription of the authors of the paper is practical, either. Perhaps we should be looking to dividends rather than stock prices and dividends should only be payable from profits of a growing concern.