Wall street greed. A CEO dillema - explained.

Imagine you are the CEO of a bank and shareholders define next year desired return of 10%. If you get more return, than your bonus will increase by 10% of that difference.

You start to imagine and evaluate a strategic plan. So, lets assume you find a way to get that result. The possible scenarios are:
- average scenario: returns 10%
- best case scenario: returns 30%
- worst case scenario: returns -5%
Because banks exists to make money, it is normal that the outcomes distribution is skewed to the profit side. This seems to be a good plan to the company.

Lets see if it is a good plan for you:
- on the average scenario you did it. Mission completed. You keep the job, and receive the normal bonus.
- on best scenario, you did a good job! Please collect your bonus with the 2% extra.
- worst case: bad job, you are dismissed. No bonus and your reputation is low. Find another career...

Hummm! I had na idea. Let's rock! Let's leverage 10x...
(for simplicity, i will forget the cost os leverage, but results are similar).

Lets see if it is a good plan for you:
- on the average scenario you overdone!100%of return. Mission completed. You keep the job, and receive the bonus with na extra 9%.
- on best scenario, you did an excellent job!300%of return Please collect your bonus with the 29% extra.
- worst case: bad job, you are dismissed. No bonus and your reputation is low. Find another career...(by the way, bank went bankrupt, but this doesn't affect you, because in this scenario you are allways a looser unemployed!)

So the leveraged strategy wins in every scenarios, so this is an easy decision: LEVERAGE!

You could even think in leverage more and more. If we take leverage costs in account, you will find na optimal leverage level.... But this level will not be necessarily risk optimal. As a rational CEO you will alllways be less sensitive to the survivorship of the company in the worst case because in that case your situation is allways bad. So you just look to increase the upside if things go well.

Its like a car race between 2 cars where the last driver to cross the finnish line is killed. In this race it is silly to be affraid of run too fast and have a serious crash. So... The only good decision is to drive as fast as possible, despite the owner of the car would prefer that the driver is killed because he was second. The crash scenario will also destroy the car.

So the big point here is that companies that are not run by the shareholders can be dangerous.