We will analyze the financial stability and the compensation of bank executives and understand why a change in compensation would improve the stability of the financial system.
In this article, the results of AlphaValue’s study “The compensation of executives of 38 listed banks in Europe over the period 2007-2010”, published in 2011, will be analysed to understand the levels of executive compensation.
The first observation is the excessive compensation of banking sector executives, which is 40% higher than the average compared to other sectors in order to provide greater stability.
The second observation is the high level of profitability criteria. The target is 15% of ROE (Return on Equity). Reaching this figure involves a considerable amount of risk. In addition, this figure is one of the main determinants of executive compensation.
The study takes the example of General society’s CEO, Frédéric Oudéa, who must meet a target of more than 15% of ROE to receive 100% of his deferred bonus in shares for 2010. In addition, this analysis is repeated by Berger and Bouwman who demonstrate that maximizing ROE leads to an increase in debt and risk.
Then in the article “The False Grail of Banking Performance” published on 19/04/2011 in the newspaper La tribune, Moussu, Ohana and Troege describe the return on equity (ROE1) as a major tool for bank management. This major tool is considered as a main indicator for the determination of managers.
These three professors issue a warning by reminding us that the increase in ROE is very easily achieved at low cost and in a safe way with an increase in financial leverage (increase in debt level compared to equity capital).
Consequently, the compensation of executives that is correlated to ROE must be modified because it can influence executives has increased the bank’s financial leverage and risk taking.