Were bankers fools or knaves?

This is a long "Control C" for a blog post, but it's worth it.  Via Simon Johnson:

New evidence in favor of the second interpretation [knaves] has just become available, thanks to the efforts of Sanjai Bhagat and Brian Bolton, who went carefully through the compensation structure of executives at the top 14 financial institutions in the United States from 2000 to 2008.

The key finding is that chief executives were “30 times more likely to be involved in a sell trade compared with an open-market buy trade” of their own bank’s stock and “the dollar value of sales of stock by bank C.E.O.’s of their own bank’s stock is about 100 times the dollar value of open market buys.” (See page 4 of the report.)

If the chief executives had really believed in what their banks were doing, they would have wanted to hold this stock – or even buy more.


Professors Bhagat and Bolton argue that if this incentive problem is important, we should see chief executives make a great deal of money while long-term buy-and-hold shareholders lose money.

Table 4 in their paper (Pages 45-48) shows the amounts of money involved, and they are simply staggering. Collectively, the people who headed these 14 institutions pocketed – in hard cash terms – more than $2.6 billion during 2000-8. It’s true that the paper value of their wealth dropped in 2008, although this was an unrealized paper loss. Even including that notional loss, the chief executives made an impressive $650 million profit [emphasis from TC].

In contrast, long-term shareholders in these 14 banks did very badly, particularly in 2008 (see Figure 1 on Page 61 of the paper). Professors Bhagat and Bolton show that shareholders in the biggest banks – where chief executives got their hands on more cash – did significantly worse than investors in smaller banks.

Interestingly, chief executives in the smallest banks in their sample did not sell much stock relative to their purchases of their own bank’s stock. The big bank-small bank contrast is quite striking.

British Prime Minister Harold Macmillan used to call them "banksters."


Not necessarily.

A great chunk of bankers compensation is in the form of options and stock. Annual stock grant is not typically available but vested during a few years. It is wise, once the stock grant is vested, to diversity your holding: sell the stock and acquire an alternative asset.

Banker reasoning is different from those who originally purchase their stock: shareholders hold the stock because they believe it will grow or pay dividends or is simly reducing the total risk of their portfolio.

I find astonishing that such moral conclusions are drawn from all this.

I'm with Vacslav. If you're given the stock as part of your compensation it makes sense to convert it into money at a prudent rate.

I meant there are 24 Cubs. There are 30 baseball teams, but the general scale is the same.

I work at an investment bank and I always sell my shares as soon as they vest. It is normal given that over 50% of compensation is in the form of restricted shares and options. They keep filling you up with more (restricted) shares every year, and it would be reckless not to diversify. Diversification does not mean not believing in your company and I think most of these execs did believe in the share price and (wrongly) believed what they were doing was beneficial for shareholders. Besides, you might actually need some of the cash

What is the control? The ratio in a corresponding 'normal' times? There was also a lot of emphasis in diversifying out of company stock post-Enron, internet bubble, etc.

"Interestingly, chief executives in the smallest banks in their sample did not sell much stock relative to their purchases of their own bank’s stock. The big bank-small bank contrast is quite striking."

Probably should have... the bailout really hurt small banks' ability to function by lowering borrowing costs for the large banks.

Agree with Vacsclav. Anyone who receives shares or options as part of compensation should look to diversify. Any executive who doesn't take the prudent step to diversify in his personal financial decisions probably isn't a wise choice to run a bank.

All stocks are risky. Banking is particularly risky because there is no intrinsic value, not due to a lack of regulation. Banking is so risky that conservative banker used to be redundant. Banking is so risky, people reflexively demand regulation.

They need to look at prior stock performance as well. For a lot of big banks simply rebalancing based on performance relative to the S&P500 would result in net sales. The whole profession harps on it being crazy to hold individual stocks. Did they look at whether the CEOs bought other stocks? Did they short the banks? They obviously didn't sell all their bank stock, what was the proportion of their net worth still invested?

"Interestingly, chief executives in the smallest banks in their sample did not sell much stock relative to their purchases of their own bank’s stock."

Were these banks where the CEO is the founder and the largest of dozens or maybe hundreds of shareholders? If so, interesting, but not surprising.

Dave, The paper goes into the diversification issue extensively, and recognizes that persons receiving stock have to diversify out of it. They even discuss percentages, time periods for holding the stock, and mix of stock and cash compensation, as it related to bank performance and risk.

This is the stupidest article yet on banker pay and incentives.

I have nothing to add to what the commenters have done above, other than to say Simon Johnson, in his increasingly desperate and strident attempts to attack the industry, well and truly seems to have jumped the shark on this one.


Simon Johnson did not do a service to his readers by not going into the details of the paper he cited, although you could expect that in a short column in a newspaper.

You might want to go to the paper itself, because many of the comments in this post are addressed in the paper, and there is factual analysis of the issues, such as stock over cash comp, percentage withdrawal amounts, personal diversification, etc.

I find it amazing that they make this argument without considering data from non-banking industries with similar stock/options compensation and similar incentive structures and similar compensation and risk levels.

Surely some comparison to Silicon Valley, etc? I read the original paper, and despite some caveats, the criticism that the paper is cavalier with the problem of sales as a rational response to diversification is not properly dealt with.

As for perverse incentives, nothing could be as perverse as the incentives of Fannie and Freddie in toto without regard to executive comp.

If this gets published in a good journal despite its poor identification and poor comparison to alternatives this will be Exhibit A in a different kind of scandal -- evidence of bias in journal editing.

Yes, the criticisms are overdone, but statements like this are simply false.

"If the chief executives had really believed in what their banks were doing, they would have wanted to hold this stock — or even buy more."

Ask Lehman Brothers if we are always masters of our own destiny. When should a CEO who believes in his company stop buying stock? Should he mortgage his house to buy more stock? Buy on margin? No. So what we need is an appropriate control group.

This appears to be the extent of how they address the diversification issue:

"While the above two reasons provide a partial explanation for the lopsided nature of the
sells to buys, it does raise the question: Is the notion of a Culture of Ownership consistent with
the empirical fact of bank CEOs selling shares of their bank 100 times the amount they buy on
the open market?"

Why would I buy any stock if it is being bought for me? My denominator would be zero, meaning that my ration would be infinity.

I checked out the paper and wouldn't say that the authors cover the diversification topic extensively. They mention it as a partial explanation for the imbalance between sells and buys. I can't understand why this isn't the primary explanation.

A pecan grower tends to his orchard and might want to consume or save some pecans, but we wouldn't expect him to buy pecans at the market.

I don't really buy this reasoning at all. If someone granted me 500,000 shares of Wells Fargo tomorrow, I would sell almost all of it the next instant (and I sure as hell wouldn't be buying any more since it is already purchased for me), and I don't work for them, or do business with them. This would pretty much apply to any single stock you granted me, and I can't imagine any reasonably knowledgeable investor would act significantly differently. Also, I could even argue that I would, myself, as an officer of the company probably feel less inclined to hold my own company's stock for reasons other than personal financial gain/loss- such as being free of accusations of trying to pump up the value of my holdings. Even if you find differential behavior amongst different corporate officers, I simply don't believe you can disentangle all the other differences between officers of different kinds of businesses.

Tyler, I guess that means you are a PC user, not a Mac user (Control C).

Epicurean Dealmaker,

Banks are an "industry" in the same way the mafia is. Only a LOT more profitable. Their latest tactic is to get their figurehead puppet Bernanke to shovel endless streams of liquidity to the primary dealers via QE2 (meanwhile overpaying for days-old federal bonds to the tune of many billions a year in free profits) so those dealers can bid up stock prices. Meanwhile that liquidity also flows in torrents into commodities, causing terrible inflation in the poorer countries where unprocessed food and energy costs are a much higher fraction of the national income than here (but it is driving our food prices sky high too, as anyone doesn't have personal servants to buy their food at the grocery store can attest).

The people in this country who actually produce value instead of being a parasite on others productivity are getting completely fed up with being robbed by Washington DC and Manhattan.

Bill: We're saying that executives generally should and do sell equity immediately upon vesting, not immediately upon grant. When companies grant equity, they require employees to hold it for a period of time for precicely the reasons you cite. But once that contractual period expires, the smart thing to do is sell.

Am I the only one that recalls that there is some outrageous marginal tax rate that kicks in at $1000000/year? If you want to pay someone $5M/year, you cannot use cash. If they actually want to SPEND their compensation, they are going to have to liquidate.

I don't doubt at all that the top money managers are robbing the public blind. I don't see any reason to believe that the mechanism proposed has anything to do with how its being done, though.

Of course they sold more than they bought. They're all paid in corporate stock, so they were all overweight that position and wanted to diversify their portfolio.

That they sold more than they bought only tells us that they received equity compensation.

I agree with the general sentiment of the comments. When a manager doesn't sell, but could, that's the weird thing that requires explanation. I sold as soon as I could when I had stock compensation. (At a private firm now...)

The one real reason I've encountered for not selling immediately is taxes, which you may be able to delay realizing or potentially lower by holding the stock longer. Arguably if you're in a really stable business (Coca-Cola comes to mind), it might be worth holding two years to make something into a long-term capital gain. If you work for Google, this is a bad idea. And it only works for some kinds of stock compensation.


I think we've known for a long time that equity compensation is a very imperfect tool. For one, we assume rational shareholders are diversified, and thus aren't super worried about the alpha risk of a particular company. Another point is that equity comp incentivizes management to dilute sharehoders. Then there is pricing and repricing of option grants (or simply piling new grants on old ones when the stock price turns down), which management can use to shore up their compensation to targets (obviously this isn't available to shareholders). And lastly there's the issue of compensation actually reflecting performance for the company, as opposed to market trends or sector trends.

Also, I don't think longer vest periods would necessarily matter, because it would just delay the onset of whatever incentive occurs at vesting - it wouldn't change it. And management would just respond with making more, smaller grants (for the same total shares), with staggered vesting dates.

Right-wing nut,

You're spot on with the tax comment. That's also why company-paid whole-life insurance policies became popular perquisites.

I also agree that simple motivation to diversify should explain most of this. I worked for a company with a large stock component in the comp, and I sold all my shares immediately on the vesting dates. Your job is already like a bond in the company; the matching contributions in your 401(k) made in company stock also keep you long-term invested. And of course vesting already keeps the grantee tied to the shares for the length of the vest, anyway. There's no need to keep your short term money all in one basket on top of that exposure.

Maybe the delta not explained by diversification could be explained by the fact that shares aren't very useful for buying things...

As for aligning management interest with shareholders, I think one of the best things we could do on that front is remove all the legal impediments to the buy-out market (e.g., poison pills, staggered boards, etc.).

@ Bill: no biggie. The article took a fairly banal set of facts and tried to make it as devious sounding as possible, so I don't blame anyone for reading it the way you did.

After browsing through the paper I have two comments:

1. The authors are aware of the diversification motive for selling stock. Their point is that the CEO should have done at least as badly as a long-term shareholder in the company if incentives were well-aligned. They find that CEOs make money over the 2000-2008 period, while a buy and hold shareholder would have lost about 25% on average. They also compare CEOs of TARP banks with non-TARP banks as a control

2. However, the results aren't as stark as the authors make them out to be. They include CEO cash compensation (ie their salary) in the measure of CEO gains. If you only look at the performance of their stock based compensation, CEOs of the large banks don't make money. The $650million gain figure contains $890 million as salary. That is, they lost a little bit of money on their stocks, but nowhere near as much as a long-term shareholder.

Vacslav has it exactly right. The authors are knaves and fools for not acknowledging it. That being said there ought to be regulations and/or incentives for all executives (not just banking executives) to be paid in stock which is locked up and can not be sold until some period after retirement. That would definitely line up the management incentives with shareholders interests/

"This is a long "Control C" for a blog post..."

And here I thought you were aborting...

Chris: Look at the tax structure for $1M +. The rules are different.

As for Bill Gates & the like, these people are much more in the position of an institutional investor that buys a percentage of a company. They are looking at board positions and the like. Managers, including CEOs without founder stock, don't have enough stock to operate in those terms.

Furthermore, if Bill were to dump 95% of his stock to diversify, it would crater the stock. There might even be covenants to prevent him from doing so.

The danger is that they'll sell the family silverware for a pittance (something that will create short term income at the expense of actual net worth) This defeats the rationale of giving them such stock in the first place.

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