

How Executive Compensation is Like the Weather - alexjmann
http://business.theatlantic.com/2009/06/how_executive_compensation_is_like_the_weather.php

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Retric
Wow, that's a load of crap.

You can link a traders pay to what they are managing not just what the firm's
overall position. The obvious solution would link 90% of their pay to the
preformance of what they manage such that losing money results in a reductin
in pay beyound what breaking even does. AKA lose all of our money and you make
nothing over the last 6 months.

There are reasons why nobobdy does this that have little to do with protecting
investors assets.

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yummyfajitas
You can only do this if the trader agrees to stay at the firm over the long
term, or perhaps if he is a daytrader.

Using your scheme, a trader simply will not enter into a contract with a great
chance of long term gain and short term fluctuations. Short term fluctuations
may eat up his pay, even if the long term gain is guaranteed.

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Retric
Plenty of people are willing to do startups for low base pay with the hope of
a high reward. The real issue is you can't really beat the market just change
your level of risk. So the real focus in investment banking is hiding risks in
ever more creative ways.

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yummyfajitas
I think you are overestimating the number of people willing to do startups.

As for beating the market, you certainly can. Plenty of people do it -- every
successful startup founder, for instance.

You can also hedge risks, which is not hiding risk but paying someone else to
assume them. This creates value: you focus on your core competency (your
business) and someone else focuses on their core competency (managing risk).

Furthermore, even those who don't _beat_ the market are contributing to
_raising the market average_. I.e., if you didn't have a bunch of people
trying to beat an average market return of 4%, then the average return would
be lower (e.g. 2%).

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Retric
ROI decreases as more money is invested in the market.

Also as an investor, beating the market is not simply ending up with more
money. I can go to Vegas with 1000$ bet on black and have a 48% chance to look
like I "beat the market" but I could have also lost money. You can change the
type of risk you are talking in roulette but a 90% chance of winning 1000$
involves a ~10% chance of losing 10,000$. This still sums to a negative number
even if it looks like a great bet most of the time.

Investing is normally a positive return over time. But, if you are willing to
lose a lot of money 5% of the time you can probably make it look like you
invested well. The risk is still there, but it normally looks like you are
"beating the market" even though you are just placing bets.

(This ignores actually producing a product or exploiting insider information.
It also ignores scams where you take a tiny risk to lose more money than you
have.)

PS: Hedging also has a cost and the net effect is a loss.

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yummyfajitas
You can't ignore producing a product. The purpose of financial markets is to
provide liquidity, hedging and information to people actually producing
products. The financial markets tell us that GM deserves no further capital
while Apple does. This increases market returns by allocating resources
towards productive investments and away from bad ones.

As for ROI decreasing as more money is invested, so what? As more money is
invested in the market, it chases more marginal investments. Thus, total
returns / total invested goes down. What's your point?

Incidentally, hedging has a _cost_. That's not the same as saying the net
effect is a loss. By that logic, all trade is a net loss due to transaction
costs. Like all trade, hedging exploits comparative advantage. If I have a
comparative advantage in making widgets and you have one in risk management,
and our comparative advantages exceed transaction costs, we have a net gain.

