Ownership & house money

One curiosity of the Turner review (pdf) is that it downplays the importance of ownership structures. Turner excuses this thus:

Many top managers of financial firms which suffered huge losses during the financial crisis (and, in the case of Lehmans, complete failure), were very large shareholders in their firms, and in several cases had voluntarily chosen to invest large proportions of cash bonuses in their firms’ equity. But these large stakes in the long-term profitability and stability of their firms did not seem to result in any greater awareness of or concerns about the risks the firms were running (p81).

I’m not convinced by this.  Mental accounting theory tells us that there’s a difference between shares one owns as a result of getting bonus payments, and shares that you’ve staked your own money in.
Shares paid as bonuses can be regarded a bit like one’s winnings in a casino. You think of them as “house money.” And people are much more willing to take risks with house money than with their original cash.
By contrast, the ownership that leads one to restrain risk-taking arises - as Alexander Hoare says - when it’s your own money at stake, rather than bonus money.
Yes, Dick Fuld “owned” a big chunk of Lehman. But it was the wrong sort of ownership. It was house money, rather than his own - and, one might add, a limited liability investment as well.
Of course, the right ownership structure won't stop all business failures - humans have an infinite number of ways of being stupid with money - but it's more of the story than Turner thinks.

Comments

[David Heigham]

The psychological perspective on 'their own' money of Fuld and Co. seems to have been similar to that of professional gamblers. These gentlemen report a sharp mental division between what is 'on the table' and the reserve left at home which you can fall back on. If that is so, the only financial disincentive that would be expected to change the behaviour of financial bosses is something that bites on their reserves. My hunch is that the liability of the responsible bosses of a regulated financial corporation needs to become much less limited should the corporation fail or be taken into administration by its regulator.

In fairness to Turner, he passes the buck on this issue to the Walker Review. He does not pretend to have considered the question in depth.

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Money owned i money owned. Some people may separate the money because it has appeared from different source, but in my case I see it as money. And I'm sure the vast majority of people. So that part of your commentary is up the creek.

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sharp mental division between what is 'on the table' and the reserve left at home which you can fall back on. If that is so, the only financial disincentive that would be expected to change the behaviour of financial bosses is something that bites on their reserves. My hunch is that the liability of the responsible bosses of a regulated financial corporation needs to become much less limasdfited should the corporation fail or be taken into administration by its regulator.