Nassim Taleb of the Black Swan fame published earlier this year a book entitled Skin in the Game: Hidden Asymmetries in Daily Life which chronicles the importance of skin-in-the-game, not only in financial risk management but also in everyday commercial transactions and even everyday life. His book made me reflect on what bank CEOs are doing in terms of skin-in-the-game. Even back in the 1800s skin-in-the-game was apparently an important concept in finance. Koudijs & Salisbury (2016) use a novel approach to measure a potential reduction in skin-in-the-game for bankers in in the 1860s and 1870s. A change in marital laws in the US meant that bankers had effectively reduced their potential alignment of interest if married and those banks were more likely to underperform (there are no Z-Score or Tail-Risk data available apparently!).
What I have noted more recently is a reduction of leveraged incentive arrangements towards a model characterised by pure equity ownership for bank executives. Some of this shift (but not all) is associated with Section 956 of the Dodd-Frank Act which requires regulators to introduce improved disclosure and standards for incentives for financial institutions staff. However, efforts to formally introduce new laws have been finalised (Federal Register, 2011 & 2016). However, shareholder groups like ISS and Norges nonetheless and industry practice are encouraging a move towards more skin-in-the-game (O'Donnell & Rodda, 2013)
My own work reveals a growing extent of CEO equity ownership since the financial crisis. Across a panel of some 100+ US BHCs, I observe an increase in CEO ownership value from $22.5 million to $33 million from 2012 to 2015. There are examples of extraordinary rewards to a select group of US BHC CEOs. Recently, Richard Fairbank, CEO of Capital One, a US BHC, was named the forth billionaire of bank CEOs in the US, in part on the back of share gains and his willingness to maintain skin-in-the-game. Other US banks which can point to billionaire CEOs include M&T Bancorp, JP Morgan and Goldman Sachs Group Inc.
While there is little empirical evidence for the post financial crisis in US financial institutions, in Europe, some studies have examined managerial incentives and impact upon risk-taking. Bouwens & Verriest (2014) write in the HBR that executive teams with greater equity ownership run banks with lower risk-taking measures including improved Z-score and volatility measures. This position is somewhat contrasted with earlier research by Fahlenbrach & Stulz (2011) who observe a material decline in BHC performance for banks with significant CEO ownership. Or does there research only say CEOs were also surprised by the speed of the crisis and remained loyal and held onto shares in a declining market?
CEO ownership/skin-in-the-game may be a increasingly important factor and risk-taking determinant as interest rate markets and credit conditions face new challenges.
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