We talked last week about how shareholders are really the last people you'd want running a bank, if you're the sort of person who doesn't like banks. Conveniently Jesse Eisinger is that sort of person, and he's pissed at shareholders for how they're running banks:
Shareholders can’t be counted on.
That’s the message from the dispiriting shareholder vote on whether to leave Jamie Dimon as both the chief executive and the chairman of JPMorgan Chase, or to split the roles. Even more shareholders backed him in his dual role this year than did last year.
For some time, reformers have hoped that shareholders might ride to the rescue to solve the problem of Bank Gigantism, otherwise known as Too Big to Fail.
Big-bank critics, like the freethinking analyst Mike Mayo, analysts at Wells Fargo, and Sheila Bair, the former head of the Federal Deposit Insurance Corporation — and others, including me — have raised the possibility that shareholders might revolt over banks’ depressed stock valuations and seek breakups. Broken-up banks would be smaller and safer.
No, it’s not going to happen. Shareholders are part of the problem, not the solution.
The problem in this telling is basically the limited liability corporation, which gives shareholders an option on the corporation's assets; option pricing theory, which informs shareholders that volatility - of earnings, of "high-risk, high-return bets" where shareholders "capture the unlimited upside and their losses are capped" - increases the value of their option; and modern corporate governance, which informs bankers that they work for the shareholders and therefore should be maximizing the value of that option. With the bets and so forth.
This all seems indisputable to me; if you don't like it one fun thing is to ponder which part you'd change. Each has its adherents; there are calls to take away limited liability for at least some elements of banking, and much work is being done to align bankers incentives' and allegiances with creditors or society rather than shareholders.1 You can even make an argument that reducing risk increases the value of the shareholders' option though you can see why that might seem suspect.2 Also there is regulation! Always regulation.
Coincidentally today Bloomberg has this article about which North American bank CEOs are overpaid and underpaid. They compare a CEO's pay ranking (among the top 20 North American banks) with his bank's average ranking on (1) common stock return in 2012, (2) return on common equity in 2012, and (3) assets as of December 2012. If your pay outranks your performance you're overpaid, and vice versa. Everyone is thus overpaid or underpaid, except Jamie Dimon, who, perfectly, is perfectly paid.3
There's much to ponder here; to get a sense of how hard a bank CEO's job is you might consider that he4 is tasked (by Bloomberg!) with maximizing both his bank's return on common equity (i.e. accounting net income divided by accounting equity) and the return on its stock (i.e. stock price increase divided by starting stock price). In 2012 that relationship was basically inverse:
Never reason from a price change, is I guess a lesson here. Also, harsh to call Brian Moynihan, paid $12mm for more than doubling BofA's stock price in a year, "overpaid" just because he did it without really earning any money? Or not? It's a mystery.
But more importantly: what are you missing when you measure a bank CEO based only on (1) his ability to make the stock go up, (2) his ability to maximize return on equity, and (3) his ability to amass assets? Bloomberg's crusadeagainsttoo-big-to-fail banks didn't prevent them from making pure bigness one-third of their measure of banker effectiveness. And while they mention that Eleanor Bloxham, "CEO of Value Alliance Co., a board advisory firm in Westerville, Ohio," thinks that bank boards should look at "capital ratios that measure financial strength" in setting pay, they nonetheless use return on common equity for another one-third of their grading. Return on equity, of course, is highly correlated with leverage (one way or the other): the lower your capital ratios, the higher your ROE for a given amount of earnings. A CEO who maximized capital ratios that measure financial strength would not be maximizing ROE, probably, though Deutsche Bank could probably find a way.
While Bloomberg's specific measures are a little incoherent,5 the gist is surely right: bank CEOs are supposed to be paid (1) for running big banks and (2) for doing so in a way that returns money to shareholders. That's what shareholders, and analysts, and the media, and everyone else, are looking for. And as long as that's the standard, people who worry that banks are too big, and too focused on risky efforts to maximize returns for shareholders, will have plenty to worry about.
Bold Beneficiaries of a Dysfunctional Financial System [DealBook / ProPublica / Jesse Eisinger]
Blankfein Leads Bank CEO Pay With $26 Million Deemed as Overpaid [Bloomberg, and chart]
Earlier:JPMorgan Shareholders Fond Of This Dimon Guy, Would Like To See More Of Him
1.Also, Eisinger quotes Lynn Stout a lot, and her whole thing is basically "everyone should ignore shareholders all the time," which is like the strong form of that.
2.Admati & Hellwig, for instance, argue (chapter 7) Modigliani-Millerishly that bank shareholders would demand a lower return on equity if banks were more thickly capitalized, because the risk premium they'd demand would be reduced. Umm sure maybe. Obviously "volatility enhances option value" is not the same as "taking dumb-ass risks enhances shareholders' option value."
3.TBF that's after they cut his pay by 50%, poor dear.
4.Or she! Beth Mooney at Keycorp is on the list.
5.The use of ordinal ranks rather than actual numbers for one thing. If bank #3's ROE is double bank #4's, that has the same effect as bank #4's CEO being paid a dollar more than bank #3's. Etc.