The political world has had one big idea on banker pay: make top executives eat more of the losses when things go wrong. While the idea has some virtue in relation to the CEOs of too-big-to-fail banks and investment bankers, it has been oversold as a cure for banking compensation more generally. While C-level executives are certainly answerable to shareholders, they must also be attuned to the bank's tail risk, or solvency — which is a chief concern of debtholders.

More important, the compensation of line-level employees has been largely missing from the recent discussion around incentive compensation. Any plan to align compensation with risk should embrace all the risk-takers in the bank. Front-line staff and their managers shape much of the risk within a bank, though because they are only responsible for the bank's solvency in the aggregate, their individual incentives may be more aligned with those of shareholders. Front-line staff cannot afford to have a significant portion of their pay delayed, nor will their incentives be aligned with the interests of shareholders by token amounts of stock. Banks that overemphasize mechanisms such as restricted stock and deferred compensation may not be able to keep talented staff long enough to achieve their aim of aligning incentives with stakeholder interests.

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