“People will play the way you pay them”
October 27, 2008 – 1:34 pm
This might be old news to readers of this blog, but still a nice way of putting it.
In this article, the Times does a good job summarizing the observations of three deans of high finance, Stephen Friedman, Marty Lipton and Joseph Rice III. These guys know what they are talking about. The comment regarding compensation should buoy those who have argued that tying pay to long term performance (perhaps something like a ten year running average) is really the only responsible way to run a company.
I think that one of the modern economy’s biggest problems is the dearth of self-aware principals in the system. Everyone seems to be an agent who profits on the up-side and moves on when things go bad.
To put it all very simply: principals are owners and agents work for them. Principals have to pay up on losses when a venture fails, but get all that is left over once all liabilities are paid. The buck stops with principals. Agents are only needed because principals can’t be everywhere at once. It’s a division of labor thing.
But, with modern portfolio diversification theory and the modern corporation, all decision makers became agents. After all, it’s not worth it for shareholders - who the law technically regards as principals - investing in index or mutual funds to monitor what goes on in an individual corporation. The fallout is that management thinks like an agent and takes big risks. Sometimes those risks go “boom.”
The fact that guys like Lipton think the super banks are here to stay scares me. The government should break these places up ASAP because of the systemic risks they pose.
Moreover, I’d be interested to know who has thought about the consequences of the big Wall Street houses going public in the 1980s and 1990s (Morgan Stanley, Goldman Sachs, etc…). If these places had still been partnerships, without limited liability for the owners, would things be different today?
I hope Obama and McCain are both thinking about this kind of thing. But, I doubt it.
Posted in Economy, Wall Street |
4 Responses to ““People will play the way you pay them””
Great post Arthur. A quote from Martin Mayer’s book on the S&L scandal seems particularly relevant:
“The root problem of politics in a modern society is the control of professional performance….What makes the S&L outrage so important a piece of American history is not the hundreds of billions of [taxpayer] dollars [lost] but the demonstration of how low our standards for professional performance have fallen in law, accounting, appraising, banking, and politics—all of them. We are farther along than anyone thought on our road to a Hobbesian society: these days you can’t trust anybody. Americans really don’t want to live this way. But they have forgotten that there are other ways.”
If everyone’s an agent, and no one’s a principal, then the buck doesn’t stop anywhere. That’s part of my problem with runaway bailouts. If you abolish the consequences of risk-taking, then everyone will keep taking imprudent risks.
By RolfeWinkler on Oct 27, 2008
Great post. (although you have a logic error in the last sentence of the 2nd paragraph, I think you want to remove the “anything but”)
Paying wall street bonuses with out-of-the-money stock options would have been one way to align incentives a bit better.
By VacantHomes on Oct 27, 2008
I’m in the insurance biz. - front line; I place coverage on your everyday risks like your car, home, business, etc.
There is a reason I won’t place $500,000 coverage on a property that someoene just bought for $100,000 - it’s called MORAL HAZARD.
This concept seems to have been lost somewhere along the way…
By shinola on Oct 28, 2008
We need an approach to this not unlike TR’s, if we are to avoid private profit against public risk/debt.
By FIXMYLOAN on Oct 29, 2008