The headlines are full of stories of huge Wall Street and CEO bonuses in spite of their companies’ disastrous financial results. All bonuses and incentive plans are based on some business model, an attempt to pick out some metric and attach dollar bills to it. The process has inherent challenges, which if not rigorously and continuously addressed, will inevitably lead to financial train wrecks.
All Models are FLAWED:
Business, like life, is complex and virtually impossible to model successfully. Many so-called genius quants have tried and failed to create trading or risk assessment models. The past is a flawed guide to the future and the future is unknown. And even if the perfect model is created, reality is a moving target. The minute a model is complete, changing circumstances begin to make it outdated.
All Models/Compensation Plans Can be Gamed:
Human beings are wonderful but I think there is something in our nature that loves to win and enjoys beating the system. The minute any compensation system is created, we begin thinking, wondering, planning how to maximize the rewards. After all, that is what the system was set up for, right? Except that a certain percentage of us will, sooner or later, attempt to game the system, figure out its weaknesses and get that cheese without putting in the expected time on the treadmill. Believe me, a way will be found.
The Inmates Are in Charge:
It is a myth that corporations are owned by the shareholders. In virtually every functional way, corporations are owned by top management; management has lobbied state legislatures successfully for decades to totally tie the hands of shareholders. While in theory shareholders have a vote, it is in a Soviet-style democracy. Top management skims off all they can in terms of perks, fat retirement plans, stock options, and golden parachutes leaving just enough for the shareholders to keep them, like the serfs of old, from revolting. Occasionally CEOs miscalculate and all the pork comes to light. Until Congress totally bans any shareholder restrictions and affirmatively requires that a majority of the shareholders are able to fire, without penalty, any and all board members (and, through the board, the top officers) at will, corporations will continue to be run for the benefit of top management.