Sub-prime bonus – Credit Suisse’s approach
01/02/2009
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In December 2008 we published details of UBS’s response to executive remuneration issues (see HERE).

While other overseas-based banks have also responded, we have not provided you with the details because, frankly, the response has been tepid, lacking imagination, or has been a re-hash of old plans that do not adequately address the twin issues of risk management and reward. We decided to distribute details of the UBS response because it was innovative, responded directly to regulators’ concerns, workable (with some serious qualifications), and most likely benefited from inside knowledge of the likely global regulatory associations’ recommendations to G20.

In this issue we make another exception, if only to underscore the asymmetry of a response that could cause it to go seriously wrong.

Could some of the highly paid bankers who concocted the exotic financial assets that helped trigger the current economic crisis be repaid in kind?

Credit Suisse is to link its top employees’ remuneration to the long-term performance of credit markets, giving them shares in a portfolio of problem loans and mortgage securities. To say that some senior staff will grumble is probably an understatement.

Mr. Brady Dougan, Credit Suisse chief executive, wants to strike a balance between the interests of the bank’s employees, shareholders and regulators. But the bank’s scheme, which includes a cash bonus and shares or options in the company, has flaws.

Bonuses should be linked directly to profitability, which senior employees are expected to influence. The risk in this case is not so much excessive compensation as the lack of sufficiently strong incentives. Staff will benefit if the value of a $5bn fund of illiquid assets in which they are shareholders increases. That may happen, given these assets have fallen to an average of 65 per cent of their original value. Employees will lose out, too, if the value of the fund falls.

Either way, though, they cannot influence the value of those assets, and so have little motivation to perform. Movements in credit markets and the actions of central banks and governments will have much more impact.

Bank staff that were not involved in the loss making leveraged loan and mortgage securities business have sound reasons to object if the value of the fund falls. Why must their pay suffer because of losses colleagues have racked up?

But investors stand to benefit from the scheme. Credit Suisse should avoid having to make further write downs on the fund’s assets because any mark-to-market gains or losses would be offset by the corresponding losses or gains on its liabilities to employees. That may make the bank’s earnings less volatile.

Credit Suisse bankers receiving equity in the fund will get no payments for at least five years.

The asymmetry of the scheme means that while investors (other than shareholders) will benefit (that’s one for the marketing department), employees will not (which is also not so good for shareholders). The danger is that the better employees (i.e. the ones that have managed risk and returns well and were not responsible for creating the mess) will depart for greener pastures where they will get a better deal.

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