Finance

Professional Sports as a Model for Bankers Compensation

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The paper proposes that professional sports has been ahead of the curve in structuring the pay of it's highest compensated individuals (the athletes). This contrasts with the banking industry, which has failed to structure pay in a reasonable fashion. Examines the three varying models used by the NFL,NBA, and MLB.
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  http://TheValueatRisk.blogspot.com   September   24,   2009   Professional   Sports   As   a   Model   For   Bankers’   Compensation   Many commentators have, in the aftermath of the destruction wrought by reckless financialindustry behavior, promulgated the view that restrictions should be placed on bankers' pay. Thetheory goes that there is a direct correlation between excessive risk taking and the expectedmonetary compensation derived from said risk taking. Most problematic is the reality that,contrary to the concept of risk - i.e it correlates with reward to the upside and loss to thedownside - it appears that a downside never actually existed for some folks. Couple thisperversion with the fact that Wall Streeter's annual compensation has reached a multiple of average US pay rivaled only by professional athletes, and it's easy to see why a lot of folks areoutraged.Watching ESPN last night, it occurred to me that professional sports has done a far superior jobin structuring compensation for it's highest value added contributors - the actual athletes - thanWall Street has managed to do for it's upper echelons. A professional sports team is in fact a self-contained business, employing a wide range of individuals who are mostly paid standard,competitive salaries. The same holds true in the banking industry; a teller working at the depositwindow is earning a modest wage, despite the handsome rewards that are doled out to thoserunning the organization. The difference between the two industries however - besides theobvious variations in core business, is that professional sports leagues in America were able toforesee the adverse effects of ballooning salaries at the top of their member organizations, andimplemented effective regulation of those salaries. Interestingly, each of the top threeprofessional sports leagues in the US - NFL, NBA and MLB - have implemented differingstrategies for tackling this problem. The three approaches can be likened to the respective leagueacting as the State, with varying degrees of interference. A brief description of each league'ssalary regulations follows:  http://TheValueatRisk.blogspot.com   September   24,   2009   National Football League  The most recentCollective Bargaining Agreement(CBA   ) between the League and the NFLPlayer's Association sets a salary cap for each team that is based upon the League's ProjectedTotal Revenues (PTR). For 2008, the formula which determined the maximum amount eachteam could spend on player salaries was (PTR X 0.575 - League wide projected Benefits) / n ,where n= the number of NFL teams for that year. Keep in mind that the CBA is a 361 pagedocument, so in addition to knowing that attorneys had a field day with this one, we can inferthat there are some exceptions to the above formula that can result in a higher or lower annualsalary cap than the formula would imply. The point is though, each team has the exact sameamount of money to spend on player's salaries each year. National Basketball Association  TheNBA's collective bargaining agreementis similar to the NFL's in that it's based upon apercentage of the League's annual revenue, and is allocated evenly across all teams. The NBA'ssystem is more flexible however, evidenced by the fact that many teams live above the salarycap. There are specific portions of the CBA which allow for salary cap violations, most notablywhen a team wishes to re-sign a veteran player who has already spent at least 3 years with theteam. There are also salary cap taxes , meaning that for instance, if a team's salaries exceed apre-specified amount, that team will be taxed by the league for it's excesses. By the way, thosetaxes are distributed evenly amongst those teams which did not disobey the salary cap. Major League Baseball  MLB's Collective Bargaining agreement, the most free-market-like in professional sports, statesthat a player's salary is an amount to be determined between the player and the owner of thebaseball team. There is no annual limit to the amount that a baseball team may spend on it'splayers salaries. There is however, a stipulation known as the Competitive Balance Tax; withoutgetting into details, the Competitive Balance Tax is the theoretical equivalent of the progressiveincome tax system in the United States.The three models above provide what I see as a relatively reasonable framework for the properstructuring of high level Wall Street pay. Salaries for each financial institution could becollectively based upon the trailing year's revenue. A substantial portion of that designated payshould be placed into an escrow account for around 5 years, and will be distributed accordinglyassuming that certain performance measures have been met for the subsequent half-decade. Inthe event that the financial institution has significant losses for a given year, the escrow accountwill be used to shore up the bank's capital position. In the event of any sort of accountingscandal, the funds will immediately be distributed - in their entirety - to shareholders.Could such a compensation model have prevented many of the problems we face today? My betis yes.  Disclosure: no positions   Copyright   2009 ‐ The   Value   at   Risk    http://TheValueatRisk.blogspot.com   September   24,   2009   For   additional   analysis   of    financial   markets   and   politics,   or   to   view   information   about   the   author,   please   visit   http://TheValueatRisk.blogspot.com   The   content   contained   within   this   newsletter,   as   well   as   The   Value   at   Risk   website,   is   provided   as   general   information   only   and   should   not   be   taken   as   investment   advice.   All   site   content   shall   not   be   construed   as   a   recommendation   to   buy   or   sell   any   security   or   financial   product,   or   to   participate   in   any   particular   trading   or   investment   strategy.   The   ideas   expressed   on   this   site   are   solely   the   opinions   of    the   author(s)   and   do   not   necessarily   represent   the   opinions   of    firms   affiliated   with   the   author(s).   The   author(s)   may   or   may   not   have   a   position   in   any   security   referenced   herein.   Any   action   that   you   take   as   a   result   of    information   or   analysis   on   this   site   is   ultimately   your   responsibility.   Consult   your   investment   adviser   before   making   any   investment   decisions.  
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