July 7, 2009

Paul Collier is worried about the skewed incentives built in to any bonus system: the upside of taking risk — a big bonus — is much bigger than the downside if the risk blows up:

The inherent problem facing shareholders is that incentive payments cannot go negative. However much damage a manager inflicts, wiping out both shareholders and depositors, the consequences cannot be remotely commensurate.

Collier has a solution: a new crime, called bankslaughter.

With bankslaughter, when the bank blows up – even if it is a decade later – a criminal investigation traces back to determine whether crucial decisions were reckless. If a reasonable banker faced with the information available at the time would not have taken those risks, the person responsible is dragged off the golf course and jailed.

Once bankslaughter was on the books, bonuses would be less dangerous. Managers would have to weigh the balance between risk and return and take defensible decisions. I doubt hyper-caution would be a problem: the overly cautious would not get bonuses. Surely we can rely on our bankers to exhibit the necessary degree of greed.

Is it reasonable to hold professionals criminally liable if they take reckless risks with other people’s money? I don’t see why not. Especially if they work at a leveraged and systemically-important institution. After all, people can be jailed for insider trading, which is far more of a victimless crime than bankslaughter.

Update: Jeff had more on this — including crediting the name to Timothy Garton Ash — last week.


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