Full disclosure: I am, like so many of my friends, an investor––a small-time one–and recently, I have joined in the public outrage about bankers’ bonuses and executive compensation in general. Compensation is one of the hot buttons in the debate over financial reform. I keep wondering why compensation practices are what they are and how they could be adjusted to calm turmoil on Wall Street.
Enter Marwaan Karame, and his version of risk analysis.
Karame heads the New York consultancy Economic Value Advisors, which coaches major corporations on Value Based Management. Value–long-term versus right-now profit–is the foundation of the firm’s philosophy. Its central principle is that any activity a business undertakes should increase the wealth of its shareholders–in the case of a privately held company, the number of shareholders may equal 1.
Karame has developed what he calls Value Based Compensation, and the goals of this are to align the self-interest of management with the self-interest of shareholders. He believes the shareholders, the company, come first. And this means a lot of decision-making under uncertainty. But Marwaan has a method for his management-shareholders balancing act, and it involves performance targets, statistical analysis, and risk assessment (in this case, managing probabilities of performance). His strategy involves maintaining a reserve of bonus funds and timing the payout of these rewards.
The point at which Monte Carlo simulation and Monte Carlo software come in is the point at which variance between performance targets and the level and timing of reward converge. He shows his his client how to click into Monte Carlo in the Excel spreadsheet and use the software to locate the tipping point between wealth for management and wealth for shareholders.
As a small–very small–shareholder, discovering that there is such a tipping point and that Karame knows how to locate it is reassuring. Makes me feel there’s someone on my side.