After the banker receives his or her first bond payment, the incentives become more complex. The banker wants last year's bonds to be paid (creating an incentive to safeguard stability) but wants a high payment this year (creating an incentive to maximize profit, which usually entails risk-taking).
Moreover, bankers could find ways to sell the long-term bonds. While regulators can require that the bonds remain unpaid by the bank, and even that bankers prove that they have not sold them, senior bankers are adept at finding loopholes. They could, for example, retain ownership of the bonds, but sell off their economic interest. Bank executives who hold large numbers of these bonds would have an incentive to lobby to dilute the bonds' guarantee. If the bank's financial condition deteriorated, their bond holdings might motivate them to conceal that and hope for a turnaround before their bonds were wiped out.
All of this highlights the imperative that regulators develop a shrewd and comprehensive strategy for supervising such a compensation system. Otherwise, it would lose its effectiveness. Compensating bankers with bonds helps to promote safety, but it does not let the regulators off the hook.
Despite these challenges, a new, bond-based compensation strategy could enhance bank stability considerably. Though there is no silver bullet for bank regulation, implementing such a system with care and vigilance would be an important step in the right direction.
Commentary by Mark Roe, a professor at Harvard Law School and an expert on securities law and financial markets. He is the author of numerous studies of the impact of politics on corporate organization and corporate governance around the world.
Copyright: Project Syndicate, 2014.