Category / Organisational Structure

Stay with me July 31, 2012 at 12:12 pm

Inspired by Jonathan Weil on the breakup (or not) of Bank of America, and with apologies to Ronnie Wood:

In the morning
Don’t say you sex me up
Cause I’ll only kick you out of the door

I know your name is Tom
Cause your losses smelling sweeter
Since when I saw you down on the floor [of the NYSE]

Won’t need to much pursuading
I don’t mean to sound degrading
But with a tax loss like that
You got nothing to laugh about

Red P/L and risk limits
I hear you’re a mean old trader
Lets go up stairs and mark to market

Stay with me
Stay with me
For this financial year you’d better stay with me

Authenticity in German Street Names January 27, 2010 at 7:15 am

Matthew Lynn writes for Bloomberg:

President Barack Obama has taken a sledgehammer to the model that Wall Street investment banks have created over the last three decades.

And yet, as is always the case in business, one man’s misfortune is another man’s opportunity.

If Europe plays this right, it could establish its banks and financial centers as the industry’s leaders. The dominance of Wall Street may be coming to an end.

In effect, “Wall Strasse” can overtake Wall Street: European financial centers can lure refugees from the tightly regulated New York markets, and the big European banks can start offering customers the all-in-one service that their U.S. rivals won’t be able to anymore.

Aside from the curious Wall Strasse coinage (‘Mauerstrasse’ would be more accurate, although the real insider would probably write ‘Theodor-Heuss-Allee’), Lynn is entirely right. This is a big opportunity for European universal banks. Paribas, Deutsche, Credit Suisse and Barclays are probably best placed to seize that opportunity, although some of them may have capital issues which will make it harder for them to take US market share.

It may well not play out like this of course, especially if Obama’s proposals are watered down significantly. But the combination of being a national champion in a leading European state and having a reasonable investment bank looks pretty attractive right now.

Location, location, location January 11, 2010 at 12:17 pm

Where do you want to be when a crisis strikes? The answer is clearly `not head office’. It was noticeable that the bankers who did well after the ’98 Russian crisis were often those who had senior positions in Asia or Latin America, and who were perceived to have acted like good corporate citizens (i.e. cut like Jack the Ripper when told to). The same thing happened after the 2001 Nasdaq crisis, and now FT alphaville reports that it is happening again:

Citigroup has just become the third big US bank (at least) in under four months to decide to pull its Japan chief out of the country… Douglas Peterson, Citi’s top executive in Japan, will shortly move to New York to become chief operating officer of Citi’s North American commercial and retail banking operations.

Being a big fish in a smallish office is often a bum deal as you are out of the HQ power loop. But it can certainly prove to be a blessing when more or less everyone back home is implicated in massive losses.

HRbots and the false comfort of quantification September 3, 2009 at 4:35 pm

One of my favourite cartoon characters is the evil HR director Catbert, from the Dilbert series. Catbert epitomises the Machiavellian intrigues and Catch 22s that epitomise the HRarchy. The character would be funny if she wasn’t so accurate.

Catbert immediately to mind when I read a Netflix presentation on their corporate values (hat tip Felix Salmon – who seems to have subsequently deleted the longer laudatory post about these slides). To precis hugely, Netflix say that they want the best people, they reward them at the top of the market so that they don’t want to leave, and they get rid of the merely mediocre.

A moment’s inspection of course reveals this to be an utter crock, in best Catbert tradition. First, it assumes that the firm’s internal mechanisms can tell if a person is any good or not. Second it assumes that being good is invariant over time: if you are good today, you’ll be good tomorrow; and if not, not. And third it assumes that a company full of good people is somehow a good thing. All of these are false.

Appraisal mechanisms, 360 feedback (or 720 or whatever) and the like are fascinating and important (from a financial standpoint) games. But I have never come across ones that do not simply validate manager’s prejudices. They often bear essentially no relationship to job performance.

The second point is even more important. An employee can be useful in some situations and less so in others. They can sit around for ten years doing nothing much useful, then save the firm. Or they can make a reasonable contribution every year without ever being a star. They can (and in the case of star executives often do) perform wonderfully for years then suddenly screw up massively.

The most pervasive HR lie of all, though, is that somehow it is in the company’s interests to have ‘the best’ employees. Have you ever tried managing a team of star performers? It makes herding cats look easy. They get bored; they all want to know what their career progression is; they fight. I’d much rather have one or two good people and a leavening of average performers. More will get done.

Furthermore, firms need diversity. They need it for the simple business reason that conditions change. If you staff up to optimise for environment X, and then suddenly find you are operating in environment Y, then you are likely to fail. But if you have a bunch of reasonably OK people who are willing to put in a decent day’s work for a decent day’s pay, then they will probably change what they do to help you out. Their self worth is not tied up with being the best person in the world at their job, and so they will probably not get depressed and sulky when it turns out that they aren’t any more.

No, meritocracy is a very dangerous concept. It assumes you can identify the meritorious, and that it is in the firm’s interests to have more of them. The more I see of firms, the more convinced I am that neither of those two things is true. Hire some reasonable people. Pay them reasonably. But don’t whatever you do ever make the mistake of believing anything someone from HR tells you.

Meritocractic mistakes July 5, 2009 at 9:53 am

Paul Kedrosky has a fascinating post on Infectious Greed about the Peter Principle.

The principle says, of course, that people climb in an organization until they reach their level of maximum incompetence…

Kedrosky discusses a simulation of organisational behaviour with meritocratic promotions and where competence in a new job has low correlation with competence at a prior level.

The authors simulated the preceding in a pyramidal organizational form using a mathematical agent model. Here is the outcome…

not only the “Peter principle” is unavoidable, but it yields in turn a significant reduction of the global efficiency of the organization.

And, of course, random promotions are better for the organisation than meritocratic ones. The source material is here. Now just try telling that to the HR bots…

Reinvigouration February 22, 2009 at 9:51 am

An article by Polly Toynbee in yesterday’s Guardian gave me pause for thought. She said:

Labour has lost its political talent. So long in power, ministers are now managers toiling in their silos, talking like policemen, devoid of political imagination.

This is clearly true. It’s hard to think of any Labour politician today of ability, stature, and judgement. Mandelson has ability but no judgement. Brown is a wonderful number 2, hopelessly at sea as leader. And I certainly can’t think of any other true talent. Blears? More of a squirrel than a politician. Smith? Fiddling your expenses is so depressingly low that she doesn’t deserve to run a sixth form debating society, let along the Home Office. Miliband? Almost certainly complicit with torture. Certainly this generation of Labour politicians are not nearly as inspiring as Robin Cook, let alone Bevin, Atlee or Morrison. The only politician of the Left that comes close is Vince Cable and he’s a liberal democrat. (Excuse me while I wash my mouth out with soap and water.)

This suggests a broader question. Is it actually possible for any party to stay in power in Britain for an extended period without using up its talent? The Tories didn’t manage it either: just compare the last Major cabinet with the first Thatcher one. Perhaps the system is set up so it is close to impossible to both govern and renew the party.

What worked, what didn’t March 9, 2008 at 10:09 am

The Senior Supervisors Group recent document, Observations on Risk Management Practices during the Recent Market Turbulence is a more interesting read than the Financial Stability Forum interim report not least because it compares leading firms who have come through recent events relatively unscathed with those that suffered some of the largest impacts.

Some of the highlight follow, with my emphasis. First the SSG identifies four firm-wide risk management practices that differentiated performance:

Through robust dialogue among members of the senior management team (including the chief executive officer, the chief risk officer, and others at that level), business line risk owners, and control functions, firms that performed well through year-end 2007 generally shared quantitative and qualitative [risk] information more effectively across the organization.

This is pure risk culture. Firms which keep risk data to the high priesthood of risk management and a few senior business leaders are not using as much of the brainpower of their organisation as they could. Further, this kind of culture tends to go with authoritarian, vertical management styles which makes it much harder to discuss issues openly and honestly.

At firms that performed better in late 2007, management had established, before the turmoil began, rigorous internal processes requiring critical judgment and discipline in the valuation of holdings of complex or potentially illiquid securities. These firms were skeptical of rating agencies’ assessments of complex structured credit securities and consequently had developed in-house expertise to conduct independent assessments of the credit quality of assets underlying the complex securities to help value their exposures appropriately. Finally, when they reached decisions on values, they sought to use those values consistently across the firm, including for their own and their counterparties’ positions. Subsequent to the onset of the turmoil, these firms were also more likely to test their valuation estimates by selling a small percentage of relevant assets to observe a price or by looking for other clues, such as disputes over the value of collateral, to assess the accuracy of their valuations of the same or similar assets.

Clearly anyone trading complex securities should have independent expertise to value them. Equally clearly once they have been valued, that value should be used consistenly throughout the firm. What’s shocking here is that some leading firms – this survey comprises eleven of the largest banks – did not have these basic control processes in place.

Those firms that avoided more significant problems through our year-end review period aligned treasury functions more closely with risk management processes, incorporating information from all businesses in global liquidity planning, including actual and contingent liquidity risk. These firms had created internal pricing mechanisms that provided incentives for individual business lines to control activities that might otherwise lead to significant balance sheet growth or unexpected reductions in capital. In particular, these firms had charged business lines appropriately for building contingent liquidity exposures to reflect the cost of obtaining liquidity in a more difficult market environment.

It so often comes down to incentive structures doesn’t it? If you charge businesses for actual and contingent liquidity, including writing liquidity lines to conduits, then they will make sure the firm is paid enough for these structures. If you don’t, they will be pretty much given away.

Firms that tended to avoid significant challenges through year-end 2007 typically had management information systems that assess risk positions using a number of tools that draw on differing underlying assumptions. Generally, management at the better performing firms had more adaptive (rather than static) risk measurement processes and systems that could rapidly alter underlying assumptions in risk measures to reflect current circumstances. They could quickly vary assumptions regarding characteristics such as asset correlations in risk measures and could customize forward-looking scenario analyses to incorporate management’s best sense of changing market conditions. Most importantly, managers at better performing firms relied on a wide range of measures of risk, sometimes including notional amounts of gross and net positions as well as profit and loss reporting, to gather more information and different perspectives on the same exposures. Moreover, they effectively balanced the use of quantitative rigor with qualitative assessments.

This is very interesting. If you have different tools with different assumptions, you have a reasonable handle on model risk. If you have one system, or multiple systems which all use the same assumptions, then you don’t. Flexible systems are clearly important, but perhaps even more significant is the mindset of looking at risk in different ways, and being sceptical about the results of any one analysis.

The report then goes on to look at three business lines where varying practices produced different outcomes. The first, unsurprisingly, is CDO structuring, warehousing, and trading businesses. Here the key issue was whether

Internal incentives were missing or inadequately calibrated to the true risk of the exposures to the super-senior tranches of CDOs.

To be fair, I doubt anyone really got this right. What may have happened, though, is that positions that were originally acquired with the intention of selling them on became prop positions when they couldn’t be sold at the mark rather than being written down until they did sell.

Next, syndication of leveraged financing loans:

Some firms worked aggressively to defend or expand market share in the syndication of leveraged financing loans, and many of those that later faced challenges in this business did not properly account for the price risk inherent in the syndicated leveraged lending pipelines.

Buying business is fine. But if you are going to pay for league table position, then at least know how much you paid for it.

Finally in conduit and SIV business we find:

Several firms did not properly recognize or control for the contingent liquidity risk in their conduit businesses or recognize the reputational risks associated with the SIV business.

For me the interesting part here is the reputational incentive. All the accounting and regulatory arguments that got these assets off balance sheet depending on the risk really passing to SIV and conduit investors. Firms that recognised that their reputational risk tolerance meant that this risk really had not been transferred clearly did better than those that pretended that the accounting and regulation followed the reality.

One more thought on pay… January 27, 2008 at 9:44 am

The columns of the FT have been reverberating with comments on banker’s pay recently (see here, here, here and here) with a predictably strident reaction from the blogosphere (see, if you must, here, here and here). One issue here that hasn’t received attention, though, is the wonderful effect of diversification for managers.

Suppose you are a junior trader with a budget of $5M and you get paid 10% of your excess P/L over $3M. Your bonus is therefore 10% x max(0, P/L – $3M). Suppose the average trader makes budget, just, and the SD of returns is $2M. Then while the average trader makes $200K, a bad or unlucky guy 2 SD from the mean makes 10% x max(0, 5M – 2 x 2M – 3M) = 0. Fair enough.

Note though that the trader owns a call, and you maximise the value of the call by increasing volatility. So the trader is incentivised to make their P/L volatility as large as possible.

Now consider the desk heads. Suppose each employs ten traders, so their budget is $50M. They too get paid on the same basis, so their bonus is 10% x max(0, P/L – $30M). The mean is $50M but the SD goes as the square root of the number of traders employed, so it is root ten times $2M or about $6M assuming zero correlation. Therefore while the average desk head takes home $2M every Christmas, a bad one 2 SD from the mean has a bonus of 10% x max(0, 50M – 2 x 6M – 30M) = $800K. So even a pretty bad (or unlucky) desk head makes money. Of course the zero correlation assumption is a stretch but note that the desk head owns a call on a basket, so they should maximise both volatility of the basket components and their correlation.

Finally consider the head of the business employing a thousand traders. By the same logic, their budget is $500M, and they get paid 10% x max(0, P/L – $300M). Their volatility though is only root thousand times $2M or $20M. So a really terrible manager four SDs from the mean still earns 10% x max(0, 500 – 4 x 20 – 300) = $12M. Very nice. Diversification works beautifully in executive pay, at least if you are one of the executives. Shareholders may have a different perspective.

A river runs through it January 10, 2008 at 8:36 am

A river of money that is. Writing in the FT, Raghuram Rajan comments on recent bonus decisions:


Banks have recently been acknowledging enormous losses, yet those losses are barely reflected in employee compensation. For example, Morgan Stanley announced a $9.4bn charge-off in the fourth quarter and at the same time increased its bonus pool by 18 per cent. The justification was that many employees had a banner year and their compensation should not be held hostage to mistakes that were made in the subprime market.

[...]

Even so, most readers would suspect something is not right here.

FT alphaville provides further background:


Banks structured bonuses to include a greater proportion of restricted stock, which is released over several years. And they set explicit targets for compensation costs as a proportion of revenues, typically around 50 per cent.

The pitch to investors was simple: we may give our staff half of everything they bring in, but this will rise and fall in line with the state of the business.

This formula worked well in boom years, but is beginning to creak. Of the Wall Street banks that have released fourth-quarter earnings so far, the two most affected by the subprime meltdown reported sharp increases in their compensation ratios. In 2007, Morgan Stanley’s wage and bonuses bill rose 18 per cent, to $16.6bn.

This in a year when the bank’s revenues fell 6 per cent, it wrote off $9.4bn in subprime losses, and was forced to raise $5bn from China Investment Corporation. At Bear Stearns, the bonus pot shrank by a fifth, but revenues fell more than a third.

[...]

There is a certain logic to this largesse. The subprime losses are generally the work of a small number of people working in the fixed income division. Meanwhile, other parts of the business have enjoyed record years. It may be in the bank’s interests to pay to keep its best people, even if there’s not much left for shareholders.

This argument fails to acknowledge the fact that all employees benefited when the fixed income operations were raking in the profits during the credit boom, and should probably share in the losses. It also highlights a fundamental flaw in the bonus culture: that costs and benefits associated with risk-taking are not equally shared.

Here’s the problem. Suppose after costs you split the pile 50/50 between shareholders and staff. Staff expect 50% of what they make. But there is no such thing as a negative bonus, and all attempts at delaying compensation or holding money back for later have proved profoundly demotivating and ineffective. So while most people are making money, paying 50% of the upside to staff is fine. But if one group loses, oh say $10B and everyone else makes money, you have a real problem, and one that slashing bonuses for the head of the business does not solve. In reality there is no collective responsibility in most investment banks and little sense of working for shareholders. Bankers are more like piece workers than traditional employees – but your average piece worker can’t endanger his employer’s capital base. The only solution to this issue will be if shareholders demand it and if the industry collectively changes: if anyone breaks ranks to gain competitive advantage, reform will fail. And we know how good investment banks are at cooperation…

John Stuart Mill on Checks and Balances March 25, 2007 at 10:20 pm

Quoted by Salon concerning the Gonzales debacle, but applicable in many other places, not least our own dear Attorney General:


Instead of the function of governing, for which it is radically unfit, the proper office of a representative assembly is to watch and control the government: to throw the light of publicity on its acts: to compel a full exposition and justification of all of them which any one considers questionable; to censure them if found condemnable, and, if the men who compose the government abuse their trust, or fulfill it in a manner which conflicts with the deliberate sense of the nation, to expel them from office, and either expressly or virtually appoint their successors.

Games lawyers play February 1, 2007 at 9:56 pm

Oh dear. First (it appears) Tony tells his Attorney General Lord Goldsmith to spare long time pet BAE from prosecution over possible corruption in a Saudi arms deal — and it turns out they are going to get their day in court anyway thanks to a different affair, this time in Tanzania. Then the cash for honours story rolls back into town with a vengeance raising questions yet again about Goldsmith’s role in deciding on possible prosecutions for Tony and his friends in this matter. Finally even the constitutional affairs minster, the usually supine Harriet Harman, calls for the Attorney General’s advice to the government be published as a matter of course. Let’s just accept, shall we, that 500 years of precedent does not naturally produce the optimal structure in all cases. Just possibly having a single individual who is both a member of the government sitting in cabinet and advising on legal matters and chief law officer with ultimate responsibility for deciding on prosecutions might conceivably be a conflict of interest… As usual in these matters, you can’t do much until the organisational structure is serviceable.

Organisational Group Think November 29, 2006 at 11:29 am

Isn’t it interesting how large firms get so caught up in their own rhetoric some times that they totally fail to appreciate how they look to the outside world. Recently we had the BA cross matryr, but the one that interests me most is the case of the Goldman Sachs cleaners. The point is not whether Goldman should pay its cleaners more as some abstract ethical or industrial relations debating point: the point is that it seems the negative publicity cannot be justified by the cost of fixing the problem. Isn’t the rational move in this game simply to make the bad news go away?

Leave the managers alone September 7, 2006 at 8:37 am

I read something rather ill-judged the other day:

Managers do not create wealth; at best, they assist others (workers) to create it; at worst, they not only produce nothing, they are actually, literally counter-productive, imposing time-wasting non-work which impedes productivity by wasting time and energy. There is no opposition between efficiency and justice; on the contrary, an institution run by those who actually do the work is likely to be more effective than one run by interchangeable exploiters who often lack any specific expertise in what they are supposedly managing.

Ignoring for a moment the repetitions and terrible grammar, one is forcefully struck by the sheer imbecilic prejudice of the author. It seems that he has never worked in a team bigger than a handful of people: if he had, he would realise that the jejune Marxist dichotomy between the workers and the owners of the means of production is utterly inappropriate for most contemporary enterprises. While it is easy for those of the doctrinaire left to set up a straw man of capitalism to knock down, it is hardly helpful to the political debate. Many of the them (and yes, George Monbiot, I do mean you too) should take the trouble to find out how corporations work before suggesting how to reform them.

Management, in all but the worst run firms, is not some extraneous layer pasted like marzipan on the solid fruit cake of production: rather it is something most workers do to some extent, the egg whites in the souffle. Successful organisations are open, collaborative, consensual: groups form around an objective; it is achieved; they dissolve. Strategy is evolutionary and co-constructed: it is not imposed by a distant elite on the ‘worker’. This isn’t just management consultancy B/S — this is what you have to do to succeed in most industries. Many firms have a lot to do in getting to this area, but criticising them on the basis of a stereotype that is decades out of date is lazy.