Highly Confused

OK, the first part is obviously true:

Richard Lambert said the bonuses rewarded success but did not penalise failure, and that if bankers had been staking their own capital they might not have taken such big risks. The CBI chief also accused investment banks of being cavalier in their attitude towards risk.

He said: "At the heart of many of Wall Street\’s problems has been a serious misalignment between the interests of managers and shareholders. It\’s clear a number of investment banks overlooked basic risk controls in their drive to increase profits.

"This pattern of behaviour has been exacerbated by a remuneration structure which has encouraged some employees to take spectacular short-term risks, confident that if things work out well they will reap huge rewards, and that if they don\’t they won\’t be around to pay the price. If it had been their own equity at risk, things might have played out differently."

That\’s the principal agent problem at play and no one is really all that sure how you solve it. Various attempts have been made of course, but there\’s no one size fits all solution.

The bonus culture has turned thousands of relatively mediocre performers in the banking industry into multi-millionaires, while top performers have earned vast sums. The head of Barclays investment banking, Bob Diamond, was paid £36m last year even though Barclays took a £1.6bn hit from the US sub-prime crisis.

Although somehave tried, of course. A significant part of Diamond\’s bonus was paid in restricted stock (ie, shares that he has to hold for a number of years) and he took a £25 million loss on such stock awarded in previous years. That\’s at least part of the way to solving the principal agent problem.

Lambert\’s view of the damage created by the City bonus culture came in his speech yesterday at the British Venture Capital Association\’s 25th anniversary summit. He said the economic climate would also show whether private equity groups operate a better business model than traditional listed companies, or whether they have just generated wealth from the cheap debt and rising asset prices of recent years. He said private equity firms now needed to show that their business model worked "without the easy access to credit and rising prices of assets".

And of course that\’s another way of solving said problem: make the principals and the agents the same people. And we will indeed see whether it\’s a total solution or not.

But to complain both about the banking model and the private equity one in the same speech does look a tad confused.

2 thoughts on “Highly Confused”

  1. “Various attempts have been made of course”: aye, but probably by the agents, so of course they don’t work. But tell me Timothy, why are all these incentivisation schemes even worth considering if it’s pretty easy for the incentivised (or their wives, mistresses or whatnots) to lay off the bet by making a contrary investment?

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