Thursday, June 17, 2010
Gillian Tett at the FT.com points to some early stage research by Hamid Mehran at the NY Fed that challenges whether it makes sense to compensate managers of banks/financial institutions with equity incentives. The problem stems from the typical capital structure of financial institutions vs other firms. Financial institutions tend to have 90-95% debt on their balance sheets while non-financial institutions have lower debt ratios - 60%. Given the high levels of leverage at financial institutions, Mehran and his co-authors argue that there is reason to believe that when bankers are compensated with equity they will chase riskier investments. All this suggests that equity-based compensation may not be a one-size-fits-all approach to inncentivizing managers. Mehran et al suggest tying compensation of banking executives to CDS spreads as a way of address the quality of their lending. Interesting. I'm looking forward to reading the paper.