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Changes to banking executives’ compensation could dramatically affect their focus and decisions.

Changes to banking executives’ compensation could dramatically affect their focus and decisions. That would be good for all of us!

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In case you hadn’t noticed, the Federal Government (who is always there to help…) has undertaken a very important and potentially significant piece of regulation. Specifically, what they are trying to do is to make rules that will change the way that large banking officials are compensated.

A bit of history is in order. In the past, the top Wall Street banking and financial institution executives were awarded bonuses based on their yearly performance. The bonuses were typically cash. While this made for a very nice New Years “pop” to their checkbooks, it created a very short term outlook by the bankers. So, decisions were made not for the long-term good, but rather for the short-term most reward regardless of the longer term consequences. This lead to some pretty shaky deals and most likely some “scams” that were NOT in everyone’s long-term best interest. The mortgage mess that spread to the entire financial system in 2008 is a perfect example of how this could affect our overall financial system. Executives were looking for bigger and bigger returns to “juice” their performance with very little concern about the long term consequences. Greater and greater risks were taken. We all know what the result of that was…

So now, regulators are focusing on “deferred compensation” and equity shares and not cash. Hooray! I think that they actually have a pretty good idea here. Now, the compensation would be “vested” over a period and not simply awarded as a big chunk of change. Further, by making the compensation stock and options, the executives will continue to have a strong motivation to keep the value of the company’s stock intact and actually try to get it to grow. So, remind me again, what is it that drives a stock’s valuation? Oh yes – earnings growth!

I hate to say it, but I think that Washington may in fact have stumbled upon a “win-win” proposal. I know, I know, it sounds too good to be true, something that is good for the finance industry and the rest of us all at the same time. Who knows what’s next… maybe a better tax system? One can only hope.

Happy Holidays and wishing you a healthy and prosperous 2011.

Jeff McAllister
OptionsANIMAL Instructor

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