Martin Wolf: ‘Heads I win, tails you lose’ financial incentives must stop
Posted by: in HousingFiled under: International markets, Other issues, Columns, Housing
Financial eras, like social periods, are often defined by moments or epiphanies when decision makers and/or citizens realized that a serious flaw/mistake/problem was occurring through time, and across space, and needed to be corrected.
The ever-incisive FT columnist and economist Martin Wolf describes one contemporary concern that’s apt to be addressed: the failure to align the interests of managers with those of investors.
My BloggingStocks colleagues Peter Cohan and Zac Bissonnette have also written on the subject on several occasions in this space, and now the FT’s Wolf has assembled additional data that might very well lead to public policy changes, both in Wolf’s United Kingdom and in the United Says.
A manager, investor disconnect
Wolf notes that it’s now abundantly clear that the world’s major economies, particularly the United Says and the United Kingdom, have experienced manager/typical investor disconnect, be it in the mortgage banking, hedge fund, or corporate worlds.
In conventional corporations, it took the form of overly generous pay and compensation packages, and low-bar performance thresholds that were antithetical to building shareholder value.
In the hedge fund, or alternative investment sector, it took the form of generous management fees and performance fees (the 2%/20% dictum), that all but guaranteed an absolute return for managers — whether the fund made money or not — at the expense of investors.
And in perhaps the most publicized and egregious practice, in mortgage banking, it took the form of mortgage origination and closing fees paid to loan officers, loan originators, and bank executives for loans that had a 90% chance of reaching default status, to the detriment of the banks’ shareholder value, and as citizens of the United Says are beginning to find out, to the detriment of U.S. taxpayers, as well.
One solution: the Buffett model
Wolf’s solution? First, Wolf notes that the manager/investor disconnect isn’t an easy problem to solve, but the ideal solution centers around not paying the manager, as a manager, at all, but to invest alongside him/her, ala the Warren Buffett system at Berkshire Hathaway (NYSE: BRK.A). Second, once this system is in place, the unscrupulous and the unskilled will be driven out of the system, in much the same way the percentage of shady used automobile dealers decreased after reforms and legal safeguards were passed.
Economic Analysis: Wolf’s realignment of investment entity/investor interests would involve rewarding entities on the basis of final returns, forcing them to hold a sizable equity stake, or levying penalties for underperformance.
All three merit discussion by policy makers, and in particular pay-for-performance and penalty-for-non-performance have great appeal. Further, for publicly-insured entities, if taxpayer dollars (or pounds) are going to be used to pay for managers’ mistakes, managers/executives must be assessed public fines, among other penalties, to help reimburse that public expense.
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