The Great Bonus Debate: Will Financial Stocks Take a Knock?

By
A A A

(Written by Rebecca Lipman. List compiled by Eben Esterhuizen, CFA)

Here’s a sensitive issue: should bankers’ bonuses be eliminated? Many have risen to debate the wisdom and folly of such a move and the slew of consequences that would come with such a drastic decision.

One angle argues that eliminating banker bonuses could solve the problem of high-risk decisions that threaten the general public. But would risk really be eliminated, or just reallocated?

The Debate

“More than three years since the global financial crisis started, financial institutions are still blowing themselves up. The latest, MF Global, filed for bankruptcy protection last week after its chief executive, Jon S. Corzine, made risky investments in European bonds. So far, lenders and shareholders have been paying the price, not taxpayers,” argues Nassim Taleb through The New York Times. “It’s time for a fundamental reform: Any person who works for a company that, regardless of its current financial health, would require a taxpayer-financed bailout if it failed, should not get a bonus, ever.”

If you’re wondering why curtailing bonuses could predictably fix the problem at hand, consider the following argument:

The bonus system “provides an incentive to take risks. The asymmetric nature of the bonus (an incentive for success without a corresponding disincentive for failure) causes hidden risks to accumulate in the financial system and become a catalyst for disaster.” And those with incentive to hide risk have a large informational advantage over the ones who have to find it. After all, risk takers are better aware of the risks and how to conceal them than investors and regulators.

Furthermore, systematically important institutions have an army of lawyers, lobbyists, and strong political connections that arguably guarantees the government would take on future bailouts despite promises to the contrary. As it is the general public that foots the bill for bailouts, the system ensures that these institutions will make little effort to reduce their risk, and that the public is increasingly taking on risk.

Corzine argues that eliminating bonuses in systematically important companies ensues employees would take on less risk because they would lack a reward system for taking the risk in the first place. It also addresses “the separation between an agent’s interests and those of the client, or principal, he is supposed to represent.” The public, in short, would be safer from taking on the consequences.

Eliminating bonuses, and risk, could hurt profit margins:

But risk taking is often a catalyst for building profits. Employees would certainly not receive bonuses if the institution didn’t theoretically make up the cost, and much more, in the work that was done. Without a healthy amount of risky decisions, these companies risk serious blows to profit margins.

Bankers often argue they need to pay big bonuses to remain competitive. Bonus-motivated workers would relocate to loosely regulated industries that reward risk-taking activities, provide bonuses based on these risks, and have little systematic importance: hedge funds.

Foreseeably, the exodus of Wall Street’s business savvy employees to hedge funds would hurt the profits of larger institutions.

Hedge funds are also more exclusive than big banks – it often takes a lot of money to work with one. Large risks here could mean great falls, but the risks would be contained in a economic group that can better take on the impact.

Will this ever happen? Would it be worth it?

Investing Ideas – Banking Sector Short Seller Targets

Will the banking sector see the most talented risk-takers depart for greener pastures? And if this is the case, which big banks are most vulnerable?

To explore this idea, we collected short trends data on the 100 largest U.S. banks. Below we list the top 10 banks being targeted by short sellers.

Short sellers seem to think these financial stocks will be dragged down by the industry’s weakness–do you agree?

Analyze These Ideas (Tools Will Open In A New Window)

1. Access a thorough description of all companies mentioned
2. Compare analyst ratings for all stocks mentioned below
3. Visualize annual returns for all stocks mentioned

List sorted by short float.

1. First Republic Bank (FRC): Provides private banking, private business banking, investment management, brokerage, trust services, and real estate lending services in California, Nevada, and New York. Current short float at 18.13%, which is equivalent to 4.64 days of average volume.

2. Valley National Bancorp (VLY): Operates as the bank holding company for Valley National Bank that provides a range of commercial, retail, trust, and investment services. Current short float at 12.16%, which is equivalent to 12.89 days of average volume.

3. Zions Bancorp. (ZION): Provides various banking and related products and services in the United States. Current short float at 9.50%, which is equivalent to 3.77 days of average volume.

4. Signature Bank (SBNY): Provides business and personal banking products and services in the New York metropolitan area. Current short float at 8.43%, which is equivalent to 6.59 days of average volume.

5. American International Group, Inc. (AIG): The company operates property and casualty insurance networks worldwide and conducts activities in the U.S. life insurance and retirement services industry. Current short float at 7.64%, which is equivalent to 2.27 days of average volume.

6. Cullen/Frost Bankers, Inc. (CFR): Provides various banking and financial products and services primarily in Texas. Current short float at 7.60%, which is equivalent to 5.96 days of average volume.

7. SVB Financial Group (SIVB): Operates as the bank and financial holding company that provides commercial banking and financial products and services. Current short float at 7.23%, which is equivalent to 4.23 days of average volume.

8. Hartford Financial Services Group Inc. (HIG): Provides insurance and financial services in the United States and internationally. Current short float at 5.87%, which is equivalent to 2.6 days of average volume.

9. W.R. Berkley Corporation (WRB): Operates as commercial lines writers in the property casualty insurance business primarily in the United States. Current short float at 5.85%, which is equivalent to 6.2 days of average volume.

10. Cincinnati Financial Corp. (CINF): Engages in the property casualty insurance business in the United States. Current short float at 5.82%, which is equivalent to 4.52 days of average volume. 



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas , Banking and Loans , Stocks


Kapitall

Kapitall

More from Kapitall:

Related Videos

Tiny Homes With Big Appeal
Tiny Homes With Big Appeal          

Stocks

Referenced

Most Active by Volume

270,887,127
    $93.89 unch
225,243,115
  • $40.93 ▼ 2.74%
135,900,109
  • $47.52 ▲ 1.80%
89,467,924
  • $5.35 ▼ 1.11%
85,105,358
  • $16.95 ▼ 0.53%
80,748,539
  • $39.80 ▼ 4.21%
68,491,586
  • $3.57 ▼ 1.79%
62,097,356
  • $100.96 ▼ 0.82%
As of 9/19/2014, 04:15 PM

Find a Credit Card

Select a credit card product by:
Select an offer:
Search
Data Provided by BankRate.com