How to Fix Bank Compensation

Timothy Geithner (Treasury Photo)

Timothy Geithner (Treasury Photo)

Joe Nocera is not impressed with the Obama administration’s new program for changing compensation schemes at major financial institutions. And I think he’s right. What Timothy Geithner announced were some good ideas for improving corporate governance—arguably ideas that should be implemented across the board—but not ideas that speak to the unusual circumstances of financial institutions that are operating with implicit government guarantees and posing unique kinds of risks to the economy.

I thought back in March that Brad DeLong had spelled out the right idea:

The engineers of Silicon Valley startups are significantly smarter and work a lot harder than do the traders of Wall Street. Some of the engineers of Silicon Valley make fortunes: they are compensated with relatively low salaries and large restricted equity stakes in the startup businesses they work for, and so if the businesses do well they do very well indeed–in the long run, in the five to ten years it takes to assess whether the business is in fact going to be a viable and profitable going concern. And the engineers of Silicon Valley have every incentive to use all their brains and all their hours to make their firm viable and successful: they get their cash only at the end of the process. They don’t get big retention bonuses if they stick around until the end of a calendar year. They don’t get big payouts if they report huge profits on a mark-to-market basis.

One of the goals of regulatory reform should be to push Wall Street out of its current compensation equilibrium and more toward what they do in Silicon Valley.