In setting incentives for senior executives, it might be the options already awarded over the years that really matter.
As eye-popping as annual compensation packages can be — JPMorgan Chase’s (JPM) chief executive, Jamie Dimon, was the biggest winner among the Big Four megabanks in 2011, with
Dimon’s holdings of such awards were worth $44 million at yearend. Because option values are so sensitive to changes in share price, just a 50% rise in JPMorgan Chase’s share price would have increased Dimon’s net worth by a full $58 million. (In fact, his company’s shares had gained 30% this year at the close of trading Monday.) From one perspective, that is as it should be: Dimon has an enormous incentive to build up JPMorgan Chase’s stock price, serving the interests of investors in the company.
But since upside outcomes can outweigh what could be lost in a wipeout, large portfolios of options can act as an inducement to make large, risky plays.
Boards should take care that incentives encoded in accumulations of stock and options awards are not “encouraging something unintended,” says Brian Tayan, a researcher at the Stanford Graduate School of Business who co-authored
“Accumulated wealth effects are likely to swamp those of year-to-year compensation,” they wrote. It could be that stock and options portfolios have been weighted to the company’s risk appetite. Or it could be that boards “haven’t thought deeply about whether incentives are appropriate.”
As with JPMorgan Chase, top executives at Wells Fargo (WFC) stood to realize huge windfalls with a rally in its stock. A 50% jump would have translated into almost a doubling of the value of their options at yearend, or an increase of about $190 million in their collective net worth, which compares with $55 million in 2011 compensation for the group. (Wells shares had in fact gained 20% this year through the close on Monday.)
By contrast, top executives at Bank of America (BAC) held only $1.6 million of options combined at yearend, and $13.4 million of unvested stock awards, whose value merely moves in lockstep with changes in share price. (Options have been valued here using the Black-Scholes model.)
Stock and option award portfolios at Citigroup (NYSE: C) were close to the level at B of A, with top executives’ holdings worth about $30 million at yearend.
The apparent split in risk appetites suggested by the compensation profiles at Wells Fargo and JPMorgan Chase, on the one hand, and at B of A and Citi, on the other, may well be justified by the relative health of the two pairs: B of A and Citi are still conserving capital. But whether deliberate or not, the Big Four appear to have gone in distinctly different directions.
