Investment banks’ pay policies still pose risk to bondholders
Despite efforts by regulators to reduce emphasis on shortterm results in determining executive compensation at the global investment banks, the time periods to receive compensation awards remain shorter than credit cycles and potential tail risks, according to a new report from Moody’s Investors Service.
The report examines pay practices at 15 investment banks: Bank of America, Barclays, BNP Paribas, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, JPMorgan Chase, Morgan Stanley, Nomura, RBC, RBS, Societe Generale and UBS.
“The compensation reforms at large banks have generally been positive, helping reduce managers’ incentive to take on excess risk,” said Christian Plath, a Moody’s vice president. “However, even with these changes, performance, vesting and deferral periods are still too short to cover credit cycles and potential tail risks.”
The changes, which in the US, UK and continental Europe have been driven by regulatory measures as well as business operating principles, include reducing the absolute size of annual incentives, deferring a greater portion of compensation to the future and significantly reducing or eliminating the use of stock options in long-term incentive plans.
However, the changes have more closely aligned senior executives’ interests with those of shareholders by tying compensation more closely to share price performance and giving shareholders a greater say on executive pay, which could have credit negative effects. As Plath said, “the risk appetites and investment horizons of shareholders and creditors don’t always align, and they’re likely to have very different ideas of what constitutes an optimal pay structure.”
The US based investment banks have the shortest periods, generally three years, whereas tail risks may play out over a 7-10 year cycle. In contrast and driven by a regulatory push, the vesting periods of UK and continental European banks are generally around 4-5 years and could be stretched further, better aligning employee compensation with risk taking and the longer-term consequences of their actions.