Wednesday, May 13, 2009

Quants Get New Opportunity, Designing Incentive Pay Schemes

Mathematical masters of the universe made financial products incomprehensible. CEO's approved the products, brokers pushed them. Greed and leverage left firms vulnerable to a precipitous fall. Now "Quants" are looking for work. President Obama has just the task. The number geniuses can create incentive pay formulas. Here's the logic:

1. Compensation practices should promote the "long-run health" of a financial institution.

2. Compensation should be structured in a way that ties closely to "actual, measurable performance" and that it does not induce "unnecessary or excessive risk taking."

3. The Fed is working rules that "will ask or tell banks to structure their compensation, not just at the very top level but down much further, in a way that is consistent with safety and soundness which means that payments, bonuses, and so on should be tied to performance and should not induce excessive risk."

Multi-year modeling of every job and its performance attributes in a financial organization, that's a good job for a Quant. Just as investors couldn't understand complex financial innovation, employees won't have a clue as to how their pay is impacted.

Pay systems are used to recruit and retain employees, motivate them in their daily work, guide long term strategic behavior, minimize organizational risk, help employees live a healthy lifestyle, and now control American financial systemic risk. Having pay perform the task of regulation is another burden, one unlikely to be successful.

The Obama team suffers from engorgementitis. To solve a problem, make it bigger. More consideration needs to be paid to the boundaries of the system needing improvement. The Supercalifragilisticexpialidocious Obama approach to problem solving is concerning.