4 ms·

How Executive Compensation is Like the Weather

7 points by alexjmann 17y ago

Retric 17y ago
Wow, that's a load of crap. You can link a traders pay to what they are managing not just what the firm's overall position. The obvious solution would link 90% of their pay to the preformance of what they manage such that losing money results in a reductin in pay beyound what breaking even does. AKA lose all of our money and you make nothing over the last 6 months. There are reasons why nobobdy does this that have little to do with protecting investors assets.
- yummyfajitas 17y ago
  You can only do this if the trader agrees to stay at the firm over the long term, or perhaps if he is a daytrader. Using your scheme, a trader simply will not enter into a contract with a great chance of long term gain and short term fluctuations. Short term fluctuations may eat up his pay, even if the long term gain is guaranteed.
  - Retric 17y ago
    Plenty of people are willing to do startups for low base pay with the hope of a high reward. The real issue is you can't really beat the market just change your level of risk. So the real focus in investment banking is hiding risks in ever more creative ways.
    - yummyfajitas 17y ago
      I think you are overestimating the number of people willing to do startups. As for beating the market, you certainly can. Plenty of people do it -- every successful startup founder, for instance. You can also hedge risks, which is not hiding risk but paying someone else to assume them. This creates value: you focus on your core competency (your business) and someone else focuses on their core competency (managing risk). Furthermore, even those who don't beat the market are contributing to raising the market average. I.e., if you didn't have a bunch of people trying to beat an average market return of 4%, then the average return would be lower (e.g. 2%).
      - Retric 17y ago
        ROI decreases as more money is invested in the market. Also as an investor, beating the market is not simply ending up with more money. I can go to Vegas with 1000$ bet on black and have a 48% chance to look like I "beat the market" but I could have also lost money. You can change the type of risk you are talking in roulette but a 90% chance of winning 1000$ involves a ~10% chance of losing 10,000$. This still sums to a negative number even if it looks like a great bet most of the time. Investing is normally a positive return over time. But, if you are willing to lose a lot of money 5% of the time you can probably make it look like you invested well. The risk is still there, but it normally looks like you are "beating the market" even though you are just placing bets. (This ignores actually producing a product or exploiting insider information. It also ignores scams where you take a tiny risk to lose more money than you have.) PS: Hedging also has a cost and the net effect is a loss.
        yummyfajitas 17y ago
        You can't ignore producing a product. The purpose of financial markets is to provide liquidity, hedging and information to people actually producing products. The financial markets tell us that GM deserves no further capital while Apple does. This increases market returns by allocating resources towards productive investments and away from bad ones. As for ROI decreasing as more money is invested, so what? As more money is invested in the market, it chases more marginal investments. Thus, total returns / total invested goes down. What's your point? Incidentally, hedging has a cost. That's not the same as saying the net effect is a loss. By that logic, all trade is a net loss due to transaction costs. Like all trade, hedging exploits comparative advantage. If I have a comparative advantage in making widgets and you have one in risk management, and our comparative advantages exceed transaction costs, we have a net gain.
- anamax 17y ago
  > You can link a traders pay to whatever the trader is willing to have her pay linked to. The more risk you ask someone to take, the more reward they're going to demand. People take jobs (in part) to reduce their volatility.
- ewjordan 17y ago
  Even a reduction in base pay is still not going to solve the true problem, though, which is a combination of the following: a) A trader's downside risk is limited at zero (worst case: trader loses his job because he screwed up, moves on to the next sucke...I mean, bank) b) His upside risk is limited only by the amount of risk he is able to swindle the risk metrics into allowing him to take on c) VaR is a really freaking easy metric to game. It's trivial to make it look like a set of risky positions are a lot less risky than they are when viewed through the distorted lens of VaR, thanks to the magic of financial engineering, which lets you create derivatives with risk profiles that match pretty much any curve you can think of. IMO the only reasonable solution is to stop pretending that VaR is a meaningful metric when applied to "sure thing" bets. If a bet is overwhelmingly likely to make a small amount of money, then you can be damn sure that it's got a tiny chance of losing a large amount of money, and VaR ignores this altogether. Traders engaging in this kind of bet either need to be watched by a person that understands what's going on or subjected to a different risk metric that adds a significant uncertainty factor to deal with the fact that we don't really know whether the risk of global financial meltdown tomorrow is .001% or .01% (fake numbers, obviously). Or (perish the thought!) maybe we should start asking ourselves whether it's really such a great idea to pay people enormous base salaries to gamble while simultaneously giving them a cut of the profits, given the fact that as a profession they really haven't proven themselves able to do anything but break even in the long run, which I could easily achieve at a far lower cost by giving a thousand monkeys "buy" and "sell" buttons to push...

7 points by alexjmann 17y ago

Wow, that's a load of crap. You can link a traders pay to what they are managing not just what the firm's overall position. The obvious solution would link 90% of their pay to the preformance of what they manage such that losing money results in a reductin in pay beyound what breaking even does. AKA lose all of our money and you make nothing over the last 6 months. There are reasons why nobobdy does this that have little to do with protecting investors assets.

yummyfajitas 17y ago
You can only do this if the trader agrees to stay at the firm over the long term, or perhaps if he is a daytrader. Using your scheme, a trader simply will not enter into a contract with a great chance of long term gain and short term fluctuations. Short term fluctuations may eat up his pay, even if the long term gain is guaranteed.
- Retric 17y ago
  Plenty of people are willing to do startups for low base pay with the hope of a high reward. The real issue is you can't really beat the market just change your level of risk. So the real focus in investment banking is hiding risks in ever more creative ways.
  - yummyfajitas 17y ago
    I think you are overestimating the number of people willing to do startups. As for beating the market, you certainly can. Plenty of people do it -- every successful startup founder, for instance. You can also hedge risks, which is not hiding risk but paying someone else to assume them. This creates value: you focus on your core competency (your business) and someone else focuses on their core competency (managing risk). Furthermore, even those who don't beat the market are contributing to raising the market average. I.e., if you didn't have a bunch of people trying to beat an average market return of 4%, then the average return would be lower (e.g. 2%).
    - Retric 17y ago
      ROI decreases as more money is invested in the market. Also as an investor, beating the market is not simply ending up with more money. I can go to Vegas with 1000$ bet on black and have a 48% chance to look like I "beat the market" but I could have also lost money. You can change the type of risk you are talking in roulette but a 90% chance of winning 1000$ involves a ~10% chance of losing 10,000$. This still sums to a negative number even if it looks like a great bet most of the time. Investing is normally a positive return over time. But, if you are willing to lose a lot of money 5% of the time you can probably make it look like you invested well. The risk is still there, but it normally looks like you are "beating the market" even though you are just placing bets. (This ignores actually producing a product or exploiting insider information. It also ignores scams where you take a tiny risk to lose more money than you have.) PS: Hedging also has a cost and the net effect is a loss.
      - yummyfajitas 17y ago
        You can't ignore producing a product. The purpose of financial markets is to provide liquidity, hedging and information to people actually producing products. The financial markets tell us that GM deserves no further capital while Apple does. This increases market returns by allocating resources towards productive investments and away from bad ones. As for ROI decreasing as more money is invested, so what? As more money is invested in the market, it chases more marginal investments. Thus, total returns / total invested goes down. What's your point? Incidentally, hedging has a cost. That's not the same as saying the net effect is a loss. By that logic, all trade is a net loss due to transaction costs. Like all trade, hedging exploits comparative advantage. If I have a comparative advantage in making widgets and you have one in risk management, and our comparative advantages exceed transaction costs, we have a net gain.
anamax 17y ago
> You can link a traders pay to whatever the trader is willing to have her pay linked to. The more risk you ask someone to take, the more reward they're going to demand. People take jobs (in part) to reduce their volatility.
ewjordan 17y ago
Even a reduction in base pay is still not going to solve the true problem, though, which is a combination of the following: a) A trader's downside risk is limited at zero (worst case: trader loses his job because he screwed up, moves on to the next sucke...I mean, bank) b) His upside risk is limited only by the amount of risk he is able to swindle the risk metrics into allowing him to take on c) VaR is a really freaking easy metric to game. It's trivial to make it look like a set of risky positions are a lot less risky than they are when viewed through the distorted lens of VaR, thanks to the magic of financial engineering, which lets you create derivatives with risk profiles that match pretty much any curve you can think of. IMO the only reasonable solution is to stop pretending that VaR is a meaningful metric when applied to "sure thing" bets. If a bet is overwhelmingly likely to make a small amount of money, then you can be damn sure that it's got a tiny chance of losing a large amount of money, and VaR ignores this altogether. Traders engaging in this kind of bet either need to be watched by a person that understands what's going on or subjected to a different risk metric that adds a significant uncertainty factor to deal with the fact that we don't really know whether the risk of global financial meltdown tomorrow is .001% or .01% (fake numbers, obviously). Or (perish the thought!) maybe we should start asking ourselves whether it's really such a great idea to pay people enormous base salaries to gamble while simultaneously giving them a cut of the profits, given the fact that as a profession they really haven't proven themselves able to do anything but break even in the long run, which I could easily achieve at a far lower cost by giving a thousand monkeys "buy" and "sell" buttons to push...