LET’S
SPECULATE AND LET THE JUNIOR EXECUTIVE TAKE THE BLAME IF IT GETS SOUR : WHEN
EXECUTIVES GET COMPENSATED FOR MISMANAGEMENT: THE CASE OF JPMORGAN
Banks and other financial
institutions will rarely admit to using shareholders contributions in speculative
transactions. They insist derivatives are solely to hedge their positions in
the market. In 1995 Nick Lesson, one of Barings
Bank of London employees, lost £827 million ($1.3 billion) due to
speculative investing, primarily in future contracts, at the bank's Singapore
office. His actions subsequently brought the bank to collapse. In January of 2008, Société Générale, one of
the largest banks in Europe, lost more than $7 billion by the actions of a
“rogue employee” named Jérôme Kerviel through elaborate fictitious trading
transactions. Société Générale chairman Daniel Bouton, decided to forgo his
salary for a six month period as a sign of taking responsibility.
There
seem to be a pattern in which only employees and lower executives take
responsibility and blame when things go sour in trading transactions that
involve large amounts of money that require the knowledge and approval of
senior executives. Senior executives take very little responsibilities or go
totally unpunished in their actions.
The
case of JPMorgan is troubling. The company revealed this year a loss of $5
billion (and growing) in derivative trades. According to a
report on Bloomberg, the “Chief Executive Officer Jamie
Dimon personally approved the strategy that led to the trades, without
monitoring how they were executed.” Even though two top executives resigned, the expectation was
that the CEO take some responsibilities, not only in words. The premise that
CEOs’ deserve large paychecks to be efficient and productive, entails they take
responsibilities when things go sour. So why is JPMorgan CEO still holding his
position?
So
much has been said and written about maximizing shareholders’ value and
aligning incentives to executives’ performance. However, we observe that the
greed of some corporate executives sways them from this objective and leads
them to illegal practice. Furthermore, these executives go virtually unpunished
and continue to get large paychecks. It is time for shareholders to put
pressure on their board members to take punitive actions against such corporate
executives.
Firing top executives because they lost money is not always the best move for the firm. Sure, management’s job is to maximize shareholder wealth, but when playing in the market, especially with future contracts, management is taking a huge risk to return maximum profits to the shareholders. I would think that management had the approval of the shareholders to play a high risk, high reward game. Shareholders know that going into such game, they may lose, so to single out the CEO of a company because of a loss, is not entirely fair.
ReplyDeleteIf the CEO is acting on his own behalf without shareholders knowledge (in most firms, monitors are in put into place to prevent moral hazard), then I would say he should be held accountable, but as long as the shareholders approve a high risk, high reward investment, then they are all to blame.
Should the CEO take some of the blame for the JP Morgan loss? Sure! But firing the executive may be going a little far, I agree with the comment from Allen. When you are playing in the high risk derivatives markets, it’s easy to get burnet. That said there are ways to mitigate some of the losses, and those channels were obviously not explored of failed to be realized. Either way they are currently facing enormous losses and if the share holders feel the CEO should be held accountable they can make that known.
ReplyDelete@Allen & Jason: Since when did derivatives cease to be instruments to hedge risk and solely a medium for speculation? You all mention that it is "high risk" when dealing with derivatives. It normally shouldn't be the case with banks. Banks I believe, should not be involved in speculation. Some of these banks are so huge that engaging in such practices can wipe out the investments of investors at the blink of the eye. True that's what it entails when you take some risk investing in the stock market. However, I truly believe investors won't invest into these firms if they knew the degree of risk involved when these companies speculate. So why is it not the best move to fire a CEO when they engage in such practices? Well, because some make the public feel they are indispensable, while their subordinates who burn the mid-night candle to get solutions get the boots! No CEO is indispensable when a firm has a layed out strategy. Steve Job is no more, Apple moves on!
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