06 December 2007
Paul Myners on Moral Hazard in banking
Following my recent entry on the moral hazard in banking, I was very interested to read Paul Myners comments on a similar theme. These comments were made in a substantial interview reported on ft.com 4th December 2007.
The full interview can be found at (subscription maybe required):
http://www.ft.com/cms/s/0/7272fc1c-a28b-11dc-81c4-0000779fd2ac.html
Specifically on the moral hazard point Mr Myners said:
"I think there’s an inbuilt moral hazard in banking. I think that isn’t just confined to banking. I think it includes private equity and other forms of investment in which the incentives to take on risk in pursuit of reward are not symmetrical to the consequences of getting that wrong. So there’s a natural inclination to stay with risk for too long. Chuck Prince embraced this in his famous statement about the music’s still playing, but I think that’s true to some extent to equity investors as well. While the market is rising, it is better to stay in than to seek to anticipate a fall, get that wrong for a short period of time, underperform against an index and benchmark and other managers, and run the risk of losing the account. So, the economic rationality that should lie behind equity and other forms of investment, doesn’t always work in the way that the economist assumes because the economist has not factored in the agency risk for the agent underperforming against expectation."
It seems to me that the problem that Mr Myners describes is not so much "inbuilt" but rather a direct consequence of the way fund managers are paid and of performance being measured over too short a timescale.
If I had my own money invested in a market that was still rising, but expected to fall significantly at some point in the next year, then I would clearly be looking to sell [Interestingly I did move significant personal money out of equities in June 2007!].
Surely then if I employ a fund manager to look after my interests then the fund manager should also be looking to sell my assets for me in this scenario. But Mr Myners points out that this strategy does not work for the fund manager because, if the market continues to rise for several months then the funds performance will look poor over this period, and the fund manager will lose his bonuses.
[I do worry that American stock values are currently propped up by fund managers looking at each others behaviour and all desperately hoping that they can get through to year end without a big fall. Should we expect a big fall early in the new year?]
It seems top me that there are two possible ways round this problem:
1) Stop all performance related pay for fund managers. They could be paid a flat salary and encouraged to take seriously their fiduciary duty to the underlying owners of the assets.
or
2) Require all performance related pay for fund managers to be linked to long term (five years?) performance measures, using a structure similar to the FILLIP described in Performance and Reward.
Obviously it is important that the people who hire fund managers also restrict their attention to long term performance. If they move their money too often they undermine the long term thinking of the fund manager. Mr Myners comments about developing the expertise of Pension Fund Trustees are important in this respect. However it is important that any "professionalism" in pension fund trustees stops short of giving them a vested interest in outcomes, or does anything to undermine their duties to the underlying owners of the funds.
The full interview can be found at (subscription maybe required):
http://www.ft.com/cms/s/0/7272fc1c-a28b-11dc-81c4-0000779fd2ac.html
Specifically on the moral hazard point Mr Myners said:
"I think there’s an inbuilt moral hazard in banking. I think that isn’t just confined to banking. I think it includes private equity and other forms of investment in which the incentives to take on risk in pursuit of reward are not symmetrical to the consequences of getting that wrong. So there’s a natural inclination to stay with risk for too long. Chuck Prince embraced this in his famous statement about the music’s still playing, but I think that’s true to some extent to equity investors as well. While the market is rising, it is better to stay in than to seek to anticipate a fall, get that wrong for a short period of time, underperform against an index and benchmark and other managers, and run the risk of losing the account. So, the economic rationality that should lie behind equity and other forms of investment, doesn’t always work in the way that the economist assumes because the economist has not factored in the agency risk for the agent underperforming against expectation."
It seems to me that the problem that Mr Myners describes is not so much "inbuilt" but rather a direct consequence of the way fund managers are paid and of performance being measured over too short a timescale.
If I had my own money invested in a market that was still rising, but expected to fall significantly at some point in the next year, then I would clearly be looking to sell [Interestingly I did move significant personal money out of equities in June 2007!].
Surely then if I employ a fund manager to look after my interests then the fund manager should also be looking to sell my assets for me in this scenario. But Mr Myners points out that this strategy does not work for the fund manager because, if the market continues to rise for several months then the funds performance will look poor over this period, and the fund manager will lose his bonuses.
[I do worry that American stock values are currently propped up by fund managers looking at each others behaviour and all desperately hoping that they can get through to year end without a big fall. Should we expect a big fall early in the new year?]
It seems top me that there are two possible ways round this problem:
1) Stop all performance related pay for fund managers. They could be paid a flat salary and encouraged to take seriously their fiduciary duty to the underlying owners of the assets.
or
2) Require all performance related pay for fund managers to be linked to long term (five years?) performance measures, using a structure similar to the FILLIP described in Performance and Reward.
Obviously it is important that the people who hire fund managers also restrict their attention to long term performance. If they move their money too often they undermine the long term thinking of the fund manager. Mr Myners comments about developing the expertise of Pension Fund Trustees are important in this respect. However it is important that any "professionalism" in pension fund trustees stops short of giving them a vested interest in outcomes, or does anything to undermine their duties to the underlying owners of the funds.
Labels: fund management, incentives, moral hazard, Myner
04 December 2007
Angela Merkel on executive pay
Following Mangela Merkel's complaints about excessive executive pay, ft.com ran a discussion, "Are top executives paid too much?" This was my contribution:
Executive Pay by Patrick Gerard 03 Dec 2007 09:24 PM
Yes, top executives are paid far to much. As the FT front page and leader reported on 15th October, even US Corporate Leaders think they are paid too much. How have we got into this situation? There are several factors:
- conflicts of interest within a unitary board
- lack of focus on fiduciary duty
- the temptation to see salary as a quantifyable (but utterly flawed) measure of business success
- Remuneration consultancies who find it easier to sell services if they promote high rewards
- Increasing professionalisation and complexity in the pay setting process, preventing outsiders from making effectively comments
- The practice of comparing salaries and seeking to pay above median
- institutional investors being so well paid themselves that they can't complain about excessive pay in management
In the UK regulatory problems have also contributed:
- Almost all the top people in the Financial Reporting Council are people who have benefited from high executive pay
- A concenus approach to the definition of the Combined Code has forced it to collude with high executive pay
- A government too dependent on support from business to raise issues that business finds difficult
Is excessive executive pay really a big problem? Absolutely yes! It creates an environment in which a manager has to "play the game" of prioritising personal rewards over the financial health of the nation. Pay (specifically stock options) was a huge factor in the dot.com crisis and short term rewards were a big factor in the credit crunch. How long before top earners are allowed to distroy our economy?Angela Merkel is absolutely right to call for intelligent regulation of these matters. Business leaders should put their own house in order before the blunt instrument of regulation does it for them.
This appeared on ft.com at:
http://www.ft.com/cms/6c2bf1ce-91b7-11da-bab9-0000779e2340.html?a=tpc&s=646099322&f=386092324&m=1781098751&r=1781098751
(subscription may be required)
Executive Pay by Patrick Gerard 03 Dec 2007 09:24 PM
Yes, top executives are paid far to much. As the FT front page and leader reported on 15th October, even US Corporate Leaders think they are paid too much. How have we got into this situation? There are several factors:
- conflicts of interest within a unitary board
- lack of focus on fiduciary duty
- the temptation to see salary as a quantifyable (but utterly flawed) measure of business success
- Remuneration consultancies who find it easier to sell services if they promote high rewards
- Increasing professionalisation and complexity in the pay setting process, preventing outsiders from making effectively comments
- The practice of comparing salaries and seeking to pay above median
- institutional investors being so well paid themselves that they can't complain about excessive pay in management
In the UK regulatory problems have also contributed:
- Almost all the top people in the Financial Reporting Council are people who have benefited from high executive pay
- A concenus approach to the definition of the Combined Code has forced it to collude with high executive pay
- A government too dependent on support from business to raise issues that business finds difficult
Is excessive executive pay really a big problem? Absolutely yes! It creates an environment in which a manager has to "play the game" of prioritising personal rewards over the financial health of the nation. Pay (specifically stock options) was a huge factor in the dot.com crisis and short term rewards were a big factor in the credit crunch. How long before top earners are allowed to distroy our economy?Angela Merkel is absolutely right to call for intelligent regulation of these matters. Business leaders should put their own house in order before the blunt instrument of regulation does it for them.
This appeared on ft.com at:
http://www.ft.com/cms/6c2bf1ce-91b7-11da-bab9-0000779e2340.html?a=tpc&s=646099322&f=386092324&m=1781098751&r=1781098751
(subscription may be required)
Labels: credit crunch, dot.com crisis, Merkel
