If you’re curious about exactly how out-of-whack incentive pay (bonuses) got in recent years on Wall Street, check out this recent NYTimes article called, “The Reckoning: On Wall Street, Bonuses, Not Profits, Were Real”, especially this tidbit that gives an order of magnitude on bonuses:
Clawing back the 2006 bonuses at Merrill would not come close to making up for the company’s losses, which exceed all the profits that the firm earned over the previous 20 years.
The article is really worth a read because it gives some more detail on how far things have gone in recent years on Wall Street (in terms of the number of people raking in millions), and also points to the core of what got us into this mess: people responding as one would expect them to to incentives that offer the potential for unprecedented personal financial gains in the short-term.
When pay systems are set up such that some of the smartest, most ambitious people stand to make enormous amounts of money if they ratchet up risk, what do you expect will be the outcome?
There’s this misplaced sense that some magical self-correcting mechanism would keep things from getting out of hand, but in retrospect it’s hard to understand why we thought the music wouldn’t stop at some point.
What strikes me is that all the watchdogs (the risk people in firms, Board compensation committees, the rating agencies, the SEC) have collectively failed in their oversight roles, and without significant change we won’t address the root of the problem.
(And while I’m no expert in executive pay, doesn’t it seem obvious that (much) less cash and (much) more restricted stock is the only way to go? Why is this so hard to get right?)