Thursday, December 16, 2010

Nocera on the Uncorporation and the Financial Crisis

Via Truth on the Market.

The Glom’s having a book club on McLean & Nocera’s All the Devils Are Here. I haven’t read the book (it takes a lot to get me to read a book by business journalists).  But I have read David Zaring’s interview with his “favorite Times columnist.  One of the questions and answers naturally piqued my interest:

Q:  Business law scholars think a great deal about how the corporate form can facilitate good business decisions.  But financial institutions tend to use corporate governance best practices (no poisons pills, dual class stock structures, plenty of outside, if not always qualified, directors), and yet have extremely high levels of insider compensation, regularly exercise poor risk management, and so on.  You’ve looked at the way the banks were run during the crisis; how did you think their corporate organization affected their performance, if at all? 

A.  It is important to remember that most Wall Street firms were partnerships before they became corporations.  When they took investment risk, they did it with the partners’ money; when they reaped rewards, it was the partners who put those rewards in their pockets.  Once the partnerships became publicly traded corporations, they were suddenly freed from the fear that losses would come out of their own pockets–it was now shareholders’ money they were putting at risk.  Yet their view of compensation never changed: the vast majority of the gains they made went not to the shareholders, but to themselves.  Most Wall Street firms put aside more than 50 of revenues–not profits, but revenues–for compensation, an astounding figure.  That is why there was so little brake on the riskiness, and even the foolishness, of the risk-taking:  all the incentives went in the opposite direction.  Having a corporate structure, in no small measure, created those warped incentives.

Click Here to Read: Nocera on the Uncorporation and the Financial Crisis

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