Calling All Shareholders

If you cast your mind back to when executive compensation and bonus limits first reached the mainstream debate, you may recall people saying these would be ineffective and the issue is a red herring.These points do not now seem compelling.  People who work at the big banks are quite irked by what they see as unjustified limits on their bonuses.  Some of the “talent” is jumping ship.  Big bank leadership is lobbying hard to remove the restrictions or, failing that, for the right to pay back government TARP funds in order to escape the bonus cap – leading firms, such as Goldman Sachs, seem poised to raise new capital to that end.

This is a remarkable moment.  Excessive risk taking in large firms was based on inappropriate bonus structures (take risk and get compensated now; face the consequences of that risk down the road), facilitated by a deep failure to understand/control risk inside these organizations and probably made possible by the implicit put option from being too big or too complex to fail (i.e., Wall Street insiders own the upside; taxpayer owns the downside).  We have all focused of late on the costs for taxpayers, which of course are horrible, and going forward – with the implicit option now explicit – who can believe this will lead to anything other than further massive bailouts?

But think about this arrangement from the perspective of shareholders.  Are we looking at the greatest tunneling scheme in the history of organized finance?

How can the large banks persuade potential shareholders to put large amounts of new capital with them, given that their systems just failed massively, these systems have not been substantially changed, and – while there has been a bailout for insiders and creditors – shareholders were largely wiped out from mid 2007-end 2008?

It could, of course, be the case that shareholders see great upside.  Anything that has fallen greatly may see some rebound.  The large banks have demonstrated their political muscle, so that should help with other forms of government protection and “rents” (economics jargon for easy money from business that others aren’t allowed into).  In the early stages of a recovery, perhaps the banks will be more generous to their shareholders; it could be that the excessive tunneling is a feature of a mad boom, and we seem some distance from having another of those.

But probably we are looking at a deeper market failure. Big money managers – including mutual funds, pension funds and insurance companies -have arguably failed in their fiduciary duty to ensure that major financial companies are run properly and in the interest of shareholders.  These money managers have great resources, many years of experience, and real power vis-a-vis the companies.  Why didn’t they push for stronger risk management?  Why are they so eager to hand over our money again?  Where exactly was or is their due diligence?

Instead of shareholder activism being limited primarily to scrutiny of companies (where it often seems to bounce off, particularly if it comes solely from small investors), it should probably be focused more intensely on money managers, including why they are not more effective at limiting the bonus culture of big finance.  Is this about their own bonus culture or their connections with the firms in which they are investing or something else?  In particular, allowing large banks to also be major money managers creates serious potential conflicts of interest at many levels.

There is discussion of encouraging people to move deposits away from big banks with a pattern of bad behavior.  But some of the most powerful banks rely relatively little on retail funding.  More effective could be reassessing the practices of debt and equity investment funds, and placing money only with those that are beyond reproach.

It may be that the behavior of these money managers cannot be corrected through the actions of their small investors acting directly or through their employers (after all, our employers should have bargaining power over the funds that manage pension money).  If we can’t sort this out through pressure, negotiation, and the market, perhaps money managers themselves should be subject to more specific legislation, implying greater regulation and sensible controls on their fee structure and strict caps on their own bonuses?


Originally published at the Baseline Scenario and reproduced here with the author’s permission.

3 Responses to "Calling All Shareholders"

  1. Guest   April 13, 2009 at 7:38 pm

    This is BS if you ask me. GS gets taxpayer money, they take on more risk because they have limited downside, they issue equity to pay back TARP so they can pay bigger bonuses (and effectively alleviate the limit to their upside). What I want to know is, why did they get the money in the first place if they are now, only a few months later, doing so well? 2. How is it that they are allowed to increase their daily risk WHILE holding taxpayer money? 3. Who will be left holding the bag if GS fails after the equity issuance? I think the answer to the last one is either shareholders/taxpayers. When will these firms be held accountable for their actions?

  2. Bayard H Waterbury III   April 14, 2009 at 1:08 am

    The rats (GS et al) have determined that the ship is leaking. They and others are undertaking the last measure of their attempt to suck us all dry, and putting their (bonus) money out of our reach before they get actually regulated. Without Glass Steagel they will continue to bilk us of every last dime they can. But their ships will sink. Every last one. The time is coming, and they’ll be lucky if any of the wealth has actual worth after all is said and done. This is their last harrah!! Read the Hollow Men by T. S. Eliot. Their world (and to some extent ours) will not end with a bang, but a whimper. The world as they and we have known is is all but come to an end. Depression has been delayed, but will happen anyway. The Oligarchs win, then lose. Look up Pyrrhic (sp?) victory, it will be theirs. In the end if you self destruct, what’s the point. It’s kind of like when an animal has fleas. No matter how many fleas, they don’t let their host die, because if it does, they do. The oligarchs should have been more careful (they, the fleas, are about to kill the animal whose blood they are living on).

  3. Anonymous   April 15, 2009 at 2:16 pm

    ENOUGH SIMON!!! YOU ARE A TOTALLY CLUELESS EX-BUREAUCRAT WITH ZERO SENSE OF WHAT IS REALLY GOING ON OUT THERE.You are trying to approach a huge issue with highschool -level analytical prowess. You really have no idea when you say that banks failed deeply to understand/control risk. You obviously do not even know what risk is – let alone placing banker behaviour within the context of the faulty system that was constructed, tolerated and regulated by public authorities.Then blaming money managers for not understanding that bankers had not understood… ludicrous, truly.The only question remaining is: ARE YOU FOR REAL?