This is from the February 23, Harvard Business Review Ideacast with Mihir Desai. The topic was CEO pay and this part of the discussion was about whether capitalism was failing (emphasis mine).
I actually think capitalism is wonderful. I actually think shareholder capitalism is a wonderful thing. I don’t have a problem with that. What I see is a significant deviation from it. Which is, again, I see managers and investment managers doing remarkably well, and shareholders doing fairly poorly if one looks at the last 15 years. That’s not shareholder capitalism. That’s capture of capitalism by managers and investment managers. That, I think, is not sustainable. That, I think, is destructive to the long-term health of shareholder capitalism.
I think this well-said. Many people often mistake distorted capitalism for capitalism.
But, the question is how can this happen in capitalism? As I like to say, the problem usually lies in the feedbacks. Desai contends that stock-performance based compensation for investment managers creates several distortions in incentives, yet the “you get paid when I get paid” logic is so alluring that it has become the generally accepted way to pay investment managers.
Desai hits on a few of these distortions, but I believe the key distortion is in the risk-taking. Investment managers share in the upside, but don’t lose their pants on the down side. The have no true skin in the game. The managers might not get paid on the downside and they may lose their contract on the downside, but they don’t actually lose their own money. So, they have more incentive to take more risk than they would if they were betting with their own money.
The next question is why hasn’t capitalism sorted out this problem? My answer is that few people know it exists.
So, here is one example where having no skin in the game has caused our financial markets to become more fragile.