JPMorgan Chase & Co. (NYSE:JPM) released a corporate governance document called "How We Do Business" last Friday that was designed to help define and strengthen its corporate culture, manage risk more effectively, and provide a high level of transparency to shareholders, customers, and regulators in the wake of a few years of scandals and legal woes that have resulted in depressed earnings. The document outlines steps JPM is taking to address deficiencies that led to the recent troubles and I believe steps taken to change the company's employee compensation policies will go a long way to align the interests of JPM employees and executives with those of the shareholders in three key ways:
1. Pay for performance compensation model will reward employees for achievements that are linked with long-term shareholder value and safety and soundness of investment.
JPM operating executive's variable compensation (i.e. bonuses) are at risk of loss if long-term business goals are not met. Performance is measured across four broad categories that account for short-, medium-, and long-term company goals: people management and leadership, risk and control focus, customer focus, and business performance. In addition, a meaningful amount of variable compensation for 30,000 JPM employees and the majority of variable compensation for executives is being issued in restricted stock that has a 3 year deferral period paid out at the share price at the time of vesting. If JPM stock price decreases in that 3 year period the value of the compensation to the executive also decreases providing an incentive to less-risky, longer-term investments. All of the compensation is forfeited if the employee quits or is terminated prior to vesting, which discourages employee turnover. By linking employee and executive compensation to longer-term metrics, the temptation to take huge risks to meet short-term business goals is eliminated and the focus shifts to creating long-term sustainable value that benefits shareholders.
2. JPM has set strong share ownership guidelines and holding requirements for operating executives, which ensures management's focus on creating long-term value.
A 2013 policy update requires that JPM's CEO must own a minimum of 1,000,000 company shares and the operating executives must own between 200,000 and 400,000 shares. Setting a sizeable minimum share number ensures that losses and gains by shareholders are equaling if not more so felt by the executives, which encourages them to make shareholder friendly decisions and more importantly discourages them from making hasty or excessively risky decisions. Many shareholders use insider stock purchases as a metric for management's focus and expectation for long-term success of the company, and JPM has made that expectation and management focus a prerequisite for the job.
3. A strong clawback policy will hold operating executives accountable for actions that negatively affect business performance in current or future year.
The clawback policy will allow JPM to reduce or cancel unvested compensation or require payback of cash or compensation already issued in situations of risk related events such as employee misconduct or failure to achieve minimum financial thresholds. Most famously JPM used this provision after the London Whale incident to clawback or cancel $100M in executive compensation, which shows that JPM is not afraid to punish those who negatively affect business performance. Most importantly, the clawback shows that JPM is willing to embrace the corporate culture and governance policy it outlines in the document.
The changes to employee and executive compensation at JPM will benefit its shareholders because it creates a culture that rewards a focus on long-term value. Performance metrics that reward employees for more than just profits and a 3-year delayed variable compensation policy increases retention of high quality employees that are both mindful of risk and focused on sustainable company growth. JPM is punishing those employees that hurt the company's business or reputation by eliminating future bonuses or requiring repayment of bonuses that were previously paid. By setting lofty share ownership requirements for executives JPM ensures that those employees making the decisions are doing so knowing that they are personally impacted by the effects, thus reducing the incentive of risky investing.
Recklessness and greed were rampant for the past several years in the banking industry and the endless scandals have tarnished the reputation of most banks, including JPM. The document was not simply a restatement of a company policy and corporate culture, but it outlines actions and measures that have been taken, and will continue to be taken to restore shareholder and customer faith in one of the largest banks in the world. Risk will never be eliminated in the banking industry, but aligning executives' level of personal compensation with that of the shareholders' value does boost my confidence that JPM executives will see less scandal and legal trouble in 2015, which should translate to shareholder gains.
Disclosure: The author is long JPM.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.