Cuomo's Findings on Banker Pay Are No Smoking Gun

New York Attorney General Andrew Cuomo says he’s got the smoking data proving that bankers’ comp is out of whack. In a nutshell, he concludes: “When the banks did well, their employees were paid well. When the banks did poorly, their employees were paid well. And when the banks did very poorly, they were bailed out by taxpayers and their employees were still paid well. Bonuses and overall compensation did not vary significantly as profits diminished.”

Predictably, reactions are all over the map. You’ve got your righteous indignation, your knee-jerk defense of Wall Street, and even the odd, and in my view more sensible, cautionary note that figuring out how to properly incent financial pros is harder than it looks.

There’s no doubt that pay in the financial world bears little relationship to performance. We’ve known that for a while now. The real question is whether excessive pay drives bankers, CEOs and their corporate kin to take foolish risks. Despite the huffing and puffing in Cuomo’s report, there’s little proof that it does. Corporate executives act recklessly for many reasons. Greed is one of them, stupidity another. But simple misjudgment in the face of daunting complexity — the fog of war — also plays a major role. And as the Times’ Floyd Norris points out, there’s even some reason to think that the nefarious effects of outsized financial bonuses are overblown.

Perhaps. But financial incentives do have some effect. Otherwise, companies wouldn’t dangle these carrots before top executives. And on this score at least one reality is emerging from the haze: Seeking to align the interests of bank managers with shareholders by rewarding execs with shares and stock options doesn’t work. A sharp plunge in a company’s stock price obviously hurts shareholders, for example, but it doesn’t affect the price of an option, which can be re-set anyway. By contrast, a CEO holding lots of options would stand to clean up if the stock soars. As a result, our exec might be just fine taking risks that the average shareholder would rather avoid.

One complication in all of this is the effect that government ownership of banks, through TARP and other federal bailout programs, has on this tricky alignment of interests. The Treasury Department has injected huge amounts of capital in numerous financial institutions, making the feds a preferred shareholder. But common shareholders, including company insiders, might well benefit from taking risks that conflict with the government’s interest as the preferred shareholder in, and chief guarantor of, these banks.

Could it be that, rather than trying to more closely align the interests of bankers and shareholders, we should instead seek to separate them?