FTSE 100
Dow Jones

Monday, 24 January 2011

A hot mug of Coco

Having spent the last fifteen years short changing the tax man and claiming the savings as profits, Barclays Capital have now turned their attention to short changing their staff with a new bonus proposal.  Now instead of getting so many zillions of cash  or shares the Barclays bonus recipients will be paid in contingent capital bonds, except that of course a million dollars of face value coco bonds isn't worth its face value.

Here's how it works.  The bank issues a bond to a bondholder and the bond pays normal interest, but if the market value of the bank's shares falls below a given price the bank is entitled to convert the bond into shares.  The bond holder has essentially written a long dated out of the money put option on the banks shares, and for that the investor wants a lower price.  This was a trick that the banks tried to pull on investors last year without much success, but being a moderately transparent exercise the investors aren't really interested in an artificial exposure that they could have created for themselves.

Investors didn't buy the idea, but now it seems Barclays will stuff the paper into their own staff, and some of the chattering classes say cocos would better align bankers’ interests with those of other bank stakeholders.

Well not quite. The numskulls say that share options encourage bankers to take big risks to keep their employer’s share price up, but cocos pay a fixed annual return, and only fall in value if an institution suffers heavy losses, which means bankers and traders will pay more attention to a firm’s overall risk profile instead of just their own division’s profits.

Which is baloney. The best form of defnce is attack and the best way of maintaining a high share price is to keep delivering high profits through risk taking. Besides which writing a put and executing a forward sale has the same payoff as buying a call option, so there is really no difference.

The real losers are the bunus recipients who receive a bonus value X%, taxable on receipt, but only receive cash in the form of interest payments, which won't be enough to pay the tax bill. And then jsut as they get their finances straight over that, they may find that they have the option exercised against them.

No comments: