Feds imposing a cap on performance

Posted by Marc Hodak on April 22, 2013 under Executive compensation | Be the First to Comment

The actual title of the article was Regulators Get Banks to Rein In Bonus Pay, but it might have been the title of this post.  The germ of this article is:

Since the financial crisis the Fed has urged banks to cap bonuses in cases where they could encourage executives to take too much risk. Before the crisis, banks erred by focusing too much on short-term profits and too little on risk when designing bonus plans for employees and executives, according to the Fed.

The Fed’s intent has devolved into policies advocating the use of measures besides profit, and the capping bonuses at something less than two times target bonuses.  These two policies ignore two, basic propositions of incentive compensation:

1)  An incentive to perform is indistinguishable from an incentive to cheat

2)  A cap on bonuses is tantamount to a cap on performance

These policies are nevertheless being advocated despite any evidence whatsoever that they help shareholders.  That is not surprising, however, since the Fed is not accountable to shareholders, but to political interests that could care less about investors.

I don’t usually offer investment tips, but here is one that is consistent with research on this matter:  Invest in companies that pay for profit growth, and don’t limit how much their executives can make.  In other words, bet against what the government is advocating.