Do you buy the argument that the current incentive system is harming morality in business? If so, and you were a shareholder of a bank, would you be in favor of completely removing incentives from the executive positions?
The Morality of Incentives
In keeping with my niche of "Business Week reactions" (as Scott called me out on), I found this BW article on the morality of incentives fascinating. The general idea is that introducing money into the equation takes morality out of the equation. A bit counterintuitive, and this assumption is backed up by some studies I am not familiar with, but I find the concept and the suggested fix intriguing.
Do you buy the argument that the current incentive system is harming morality in business? If so, and you were a shareholder of a bank, would you be in favor of completely removing incentives from the executive positions?
Do you buy the argument that the current incentive system is harming morality in business? If so, and you were a shareholder of a bank, would you be in favor of completely removing incentives from the executive positions?
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I think it's close to the problem, but not close enough. My take away was this key passage:
ReplyDelete"...consider credit unions and community development banks. Many have subprime mortgage portfolios that remain healthy to this day. In large part, that's because they approve loans they intend to keep on their books rather than securitizing and selling them to drive up revenue, which would in turn boost annual bonuses. And help bring the world economy to its knees."
As I have mentioned before, you don't need to remove incentives from the equation, you need to make incentives based on the long term success of the company. Executives will really care about the company when their bonus depends on how the company is doing five years down the road.
Aaron, how would you define long term success in a quantifiable way to tie it to bonuses? Or would it be a more subjective method like the board of directors voting on it?
ReplyDeleteWell, as I've mentioned before, a five year vesting on stock bonuses should be long enough that executives will not sacrifice the well being of the company for their own gain, but short enough that the bonuses still adequately incentivize. Besides, this is for the multi-million dollar bonuses on top of their more than adequate salary. And by vesting, I do not mean that they need to remain with the company, rather they simply have to wait to benefit from the large stock bonuses. This would also deter them from establishing a lifestyle beyond their consistent income, so that they don't feel they need to earn the super large bonus every year.
ReplyDeleteSo you'd still tie it to stock price, just over a five year period? The cynic would say that all you're doing is encouraging the CEO to find ways to bloat that stock price for a five year period, but not necessarily to build long-term, safe, sustainable growth for the company
ReplyDeleteStock price is just easier. You can come up with any formula that quantifies profitability and/or growth year over year. The five year vesting won't encourage the CEO or any other executive to target the five year window, because the second year he gets another bonus that vests over five years, and the 3rd year he gets another bonus, and so on. After five years, he will always have previous bonuses vesting every year and have current and recent bonuses vesting in the future. Theoretically it would encourage steadier growth.
ReplyDeleteThe bonus does not necessarily have to be in the form of stock, it could be a cash bonus relative to the stock price.