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Sallie Krawcheck: Top 10 Reasons It’s Bad to Pay Bankers in Stock

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Sallie Krawcheck didn’t pull any punches when she was president of Bank of America-Merrill Lynch’s wealth management unit, and now she’s using her bully pulpit as a LinkedIn blogger to explain why paying bankers in stock is a lousy idea.

In 2013, banks must change the way they compensate their senior executives, Krawcheck (left) argues in her Tuesday blog post, saying that company boards are making a mistake by moving to more equity ownership for senior execs since the 2008 crash. She certainly has an insider’s view of the business: Krawcheck is a veteran not only of BofA, but of Citi Smith Barney and Sanford C. Bernstein & Co.

“Coming out of the crisis, the national discussion focused on ‘pay them less’ and very little on ‘pay them better,’” writes Krawcheck, who was summarily fired in September 2011 when BOFA Chief Executive Brian Moynihan went public with plans to reorganize the bank’s management and operating units. “Instead, the long-term conventional wisdom that senior executives should be aligned with equity holders remained unexamined: the amount they are paid is often based on stockholder metrics (like ROE), and the form of payment is in increasing proportions of stock.”

Krawcheck, who majored in journalism at the University of North Carolina at Chapel Hill before going on to earn her MBA from Columbia Business School, says it’s time for large banks’ boards to come up with new payment strategies for executives, such as bonds, “which are fundamentally risk-discouraging.”

Claiming that she herself and the rest of the banking world now know that their business is unlike any other, Krawcheck then goes on to list her top 10 reasons paying bank executives in more stock is “a bad idea.” (See No. 10 on the list, where Krawcheck name-checks her former firm.)

1. Equities encourage risk. While a stock’s downside is capped at $0, its upside isn’t, Krawcheck says. “Therefore, the right play over time is to take on more risk, to try to capture that asynchronous upside.”

2. Equities encourage risk, part 2. “Did you ever buy a stock because you hoped to get back just your principal? No. You bought it because you wanted it to go up,” Krawcheck says, adding that company management assumes bigger risks to grow earnings and returns.

3. Equity holders have short-term horizons.  “I can’t tell you how many times I’ve been in meetings with equity investors in which they encouraged/pushed the bank management team to grow earnings more quickly,” she writes. “No, not always hedge fund managers; also conventional mutual fund managers looking to reap the benefits of short-term performance for their own hugely important quarterly performance reporting periods.”

4. Banks already have plenty of risk. Krawcheck points out that the industry by its very nature carries risk in the form of consumer credit (hello subprime mortgages), corporate credit (General Motors, anybody?), interest rates, markets, currency, liquidity, compliance…and the list goes on…

5. The impact of misjudging and mismanaging that risk extends beyond equity holders. Big U.S. banks fund themselves with an average of $13.5 of debt and deposits for every $1 of equity, and that means equity is just a small part of a bank’s capitalization, Krawcheck writes. “With equity compensation, bank executives’ incentives are directly aligned with only one of their funding sources…and by far the smallest one at that.”

6. The impact of misjudging and mismanaging risk extends even further. Since banks sit at the center of the economy, their activities have a multiplier effect on markets, growth and even Main Street’s psyche. “Why should bank executives only be aligned with equity holders?” she asks.

7. The margin of error for mistakes is low.  “A loss equating to just 7.4% of a bank’s net assets completely wipes out equity,” Krawcheck notes.

8. The chances of these types of declines has been increasing as the volatility of bank assets has risen. Pointing to further evidence, Krawcheck cites Andy Haldane, executive director for financial stability at the Bank of England, who asserts that the volatility of bank asset returns has increased 2.5 times over the past 100 years.

9. Big banks are bigger than ever. “The top five banks account for 52% of bank assets, up from 30% in 2001 and 17% in 1970, according to Fed numbers,” writes the former journalism student, who has clearly done her homework. “It used to be that many management teams had to make mistakes simultaneously for it to matter; now that risk is no longer as diversified.”

10. Look at the evidence. Naming names, Krawcheck points out that the biggest CEO equity holders in 2007 were at Lehman Brothers, Bear Stearns, Merrill Lynch, Morgan Stanley and Countrywide. As she puts it: “‘Nuff said.”

Read 11 Things Sallie Krawcheck Learned: ‘When I Got Fired (the First Time)’ at AdvisorOne.