JPMorgan CEO Jamie Dimon gets $23 million pay package despite the bank's $2 billion loss
Ingo Walter and Jennifer Carpenter: Real concern should not be level of executive pay
They say bank shareholders and employees have incentives to take risks to make more money
Focus on changing risk incentives rather than amount of pay, the writers say
Editor’s Note: Ingo Walter is the Seymour Milstein professor of finance, corporate governance and ethics, and Jennifer Carpenter is an associate professor of finance in the Stern School of Business at New York University.
Here we go again. The perennial question of: “Would you rather own shares in a major financial conglomerate or manage one?” comes up as JPMorgan Chase loses more than $2 billion in trading bets.
The answer seems clear. If you’re an executive who manages the money, you’re likely to get a large paycheck and bonus even if you’re responsible for the loss, directly or indirectly. Jamie Dimon is still getting his $23 million.
Shares of the major banks continue to trade well below book value and generate miserable performance metrics – and have over the years been very poor investments – while senior executives and key employees continue to walk away with vastly outsize earnings, even when they oversee massive losses.
Shareholders certainly have reasons to object to huge executive pay packages, especially ordinary people whose fund managers have put in stakes of the bank shares in their pension and mutual fund accounts.
But the level of executive compensation comes out of shareholders’ pockets. If shareholders are unhappy with the division of the spoils, they have no one to blame but themselves. After all, they can always take their money elsewhere if they don’t think their cut of bank profits is big enough.
The real concern for everyone – including regulators and taxpayers – is not the level of pay handed out to executives, nor how profits in a company are divided between employees and shareholders, but rather, the incentives for risk-taking that bank pay apparently continues to create.
Regulators have called for deferred compensation to address the incentive problem. If deferred compensation presents employees with serious exposure to potentially big losses, they’ll have a major stake in the long-term solvency of the business and help spare taxpayers the cost of bailing out firms that have become too systemically important to fail.
But forcing employees to bear significant exposure to potentially big losses may come at a price. Employees may require higher salaries to compensate for increased risk. We’re seeing this reflected in recently announced pay packages. The price is paid primarily by shareholders while the benefits of any improvement in financial stability accrue to society as a whole.
Deferred cash compensation makes employees debt holders, so it ought to reduce risk-taking. So should compensation in a form that explicitly converts to equity when the firm gets into trouble and is bailout-proof.
Deferred stock compensation, however, may do just the opposite. As long as there are implicit government guarantees for financial institutions that are considered too big, too complex or too interconnected to fail, the value of those institutions’ stocks increases with risk-taking.
The more risk a bank takes, the greater the value of government guarantees and potential bailouts. This value gets passed on to the bank’s stock price. If employees are paid in deferred stock, the risk incentives are then passed on to them, encouraging them to speculate.
Rules that mandate more pay in the form of stock miss the point. It helps align the interests of employees and shareholders, but it fails to align their interests with those of taxpayers.
Ultimately, it’s the taxpayers who are held hostage. They care about the size of bailout necessitated by excessive risk-taking taken by banks, and about economic growth, but not about how bank profits are divided per se, since they don’t get a cut in any case.
Regulators are aware that bank stockholders have an overriding desire to take more risk than is good for society because chronic under-pricing of government guarantees makes it profitable for banks to seek risky assets and lever them as much as possible. This is the reason for capital requirements and the Volcker Rule, which tries to restrict risk-taking.
Recent attempts to reform compensation overlook how complicated the compensation process can be. Trying to discourage risky behavior is like fighting an uphill battle against shareholders who like risk. Moreover, risk incentives are harder to measure, and their regulation is easy to circumvent.
Criticizing the compensation packages of JPMorgan’s Dimon and his senior associates might be popular with voters, but regulators would be better off focusing on the source of the problem – the mispricing of government guarantees that create perverse risk incentives in the first place.
Pricing deposit insurance differently or banning activities such as proprietary trading would give shareholders and employees alike an incentive to rein in risk-taking. Employee compensation would then reform itself.
The opinions expressed in this commentary are solely those of Ingo Walter and Jennifer Carpenter.