Creditors' one-way bets may be called in
November 26, 2007
By Ethel Hazelhurst
Shareholder activists are trying to make their presence felt in what is likely to become a long-running battle with one of the world's biggest banks.
Knight Vinke Asset Management, which holds a stake of less than 1 percent of British bank HSBC, is objecting to the performance-related rewards that are likely to be paid to its senior executives next March. Knight Vinke said these payments could be substantial.
This is despite more than $20 billion (R137 billion) in provisions made for credit- and trading-related losses over the past two years.
The bank last week reported bad debts worth $3.4 billion in the third quarter, relating to problems in the US subprime mortgage market. The announcement followed the firing of the head of its US mortgage lending business in February.
But Knight Vinke was making a different point. It said performance targets introduced in 2005 were not nearly as demanding as they seemed. And it said the plan should be resubmitted to shareholders because previous information was "misleading and insufficient".
Knight Vinke, which says it is two months into a three-year campaign, is now attempting to embarrass HSBC.
The bank, however, is standing firm, insisting it "engaged widely" with shareholders when the scheme was introduced.
But surely that's all beside the point?
It's hard to imagine the performance targets included $20 billion worth of provisions due to bad judgment by the management team. So, whatever the merits of the original targets, it's clear the senior executives deserve no reward.
The problem with performance-related bonuses is that they are asymmetrical: even when things go so badly wrong that the top people get the chop, they usually leave with a massive golden handshake.
Former Merrill Lynch chairman and chief executive Stan O'Neal got $161 million when he lost his job after the bank wrote down nearly $8 billion in losses related to subprime mortgage debt. And the former head of Citigroup, Charles Prince, got $29.5 million in share awards, share options and pension entitlements.
The people who pay the penalty when the top brass make a bad call are those who are retrenched when their organisations are forced to cut costs in the wake of the resulting disaster.
And so do the shareholders, who see the value of their assets slashed as the company loses credibility in the market. Bloomberg reported on Friday that HSBC shares had fallen 11 percent this year.
The arrangement shouldn't be a one-way bet that encourages decision makers to take on unreasonable risks, knowing they can cut and run if the worst case scenario unfolds. If senior executives get a reward for doing things right, they should also take a pay cut when they do things demonstrably wrong.
The subprime disaster raises other governance issues.
On the one hand, it was part of a genuine attempt to extend access to finance to low-income people.
But clearly not enough care was taken to devise a sustainable product.
Too many people selling the product were no doubt spurred by a commission rather than a noble motive. The result is a huge increase in the number of economically displaced people, as countless defaulting borrowers will be forced out of their homes over the next few years.
The debacle is a setback for efforts to lend to the poor. Groups campaigning to get low-income finance will have to contend with the subprime bad press.
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