Name Bank CEOs and Conduct CostsDate 2014-01-03 00:00:00 +0000Text
LLB Law – London School of Economics
The CEO stands for the idea behind a financial institution’s activities. The CEO’s way of thinking defines the work of all the bank’s employees and the culture that connects the bank to its customers. The extent to which the bank is sustainable ultimately depends on this figure. The Conduct Costs Project serves as a strong indicator of success or failure in this regard. This post outlines a framework in favour of sustainability through the incentivising of CEOs; this comes about by rewarding performance through options to buy shares, rather than bonuses. The post suggests that the Conduct Costs Project serves as the factual basis for the attainment or non-attainment of sustainable banking; the Project makes them harder to deny. The Project’s work therefore solidifies sustainability as a concrete and modern concept in financial markets.
The bank as a corporation has no limits on how long it can operate. But a bank CEO will typically serve for a few years, during which they will put their vision into full swing. Immediately, we have a conflict between CEOs short term goals of achieving personal success, through large bonuses, contrasted against the longevity needed to connect a bank’s activities to its customers. To avoid this problem of CEOs personal interests coinciding with the bank’s long term pursuits; banks can design structures to keep their CEOs prioritising the institution’s goals. This can be addressed by the CEO’s employment contract, with terms relating compensation to the performance of the bank and its stock. The outcomes of this employment contract, in essence, the results produced by CEOs, are reflected in financial market prices. When CEOs produce solid results, the prices of their bank shares go up. When CEOs fail, the prices fall.
Incentivising by this method of stock options is more favourable than awarding bonuses to CEOs for achieving high profits. Profits based bonuses might encourage them to merely milk the company in the short run, and leave a disastrous situation for their successors. With stock price related incentives, CEOs are encouraged to steer the company towards long term activity. That long term activity in this case is sustainable banking. A CEO actively monitors the movement of the bank’s share price. It is like a continuous “report card” (Professor Robert Shiller in Finance and the Good Society pp.20) on his or her activities. This continuous report card is what allows a dispensation to a CEO, of stock or options in the bank’s shares. It successfully aligns the CEO’s incentives with those of the bank. An option to buy a share in the bank at a specified price is valuable only if the actual market price is higher, and so granting options to the CEO creates an incentive to take actions that will boost the bank’s share price in the long term.
For the above reasons, action to increase profitability can be directed towards sustainability, with the Conduct Costs Project as an indicator of a bank’s sustainable performance. The Conduct Costs Project represents a focused agenda which pushes banks to admit their failings and represent their figures more accurately. The crux of this is that we should direct these important findings to the figure which stands behind the activities that incur conduct costs in the first place – The CEO.
A bank’s favourable share price is not necessarily an indicator that the bank is sustainable. However, the same way in which a bank’s favourable share price incentivises a CEO through options, is the same way the Conduct Costs Project can be used as an indicator of sustainability. The argument is that it is the CEO who best reflects a bank’s culture and we should direct a bank’s criticism to them. Therefore, if investors are made aware of banking practices which incur conduct costs, they can react negatively by contributing to falls in prices of the banks’ shares. This then becomes a personal issue for the CEO who will incur unfavourable financial options through this fall in share price. A bank CEO’s short term interest is alleviated by this financial structure; it motivates him\her to focus on the long term goal of sustainability; it does this by indicating, with numbers, whether or not they are pursuing that goal in their respective banks.
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