Bankers had cashed in before the music stopped, by Lucian Bebchuk, Alma Cohen, and Holger Spamann, Commentary, Financial Times: According to the standard narrative, the meltdown of Bear Stearns and Lehman Brothers largely wiped out the wealth of their top executives. Many – in the media, academia and the financial sector – have used this account to dismiss the view that pay structures caused excessive risk-taking and that reforming such structures is important. That standard narrative, however, turns out to be incorrect.
It is true that the top executives at both banks suffered significant losses on shares they held when their companies collapsed. But our analysis … shows the banks’ top five executives had cashed out such large amounts since the beginning of this decade that, even after the losses, their net pay-offs during this period were substantially positive. …
Our analysis undermines the claims that executives’ losses on shares during the collapses establish that they did not have incentives to take excessive risks. …[R]epeatedly cashing in large amounts of performance-based compensation based on short-term results did provide perverse incentives – incentives to improve short-term results even at the cost of an excessive rise in the risk of large losses at some (uncertain) point in the future.
To be sure, executives’ risk-taking might have been driven by a failure to recognise risks or by excessive optimism, and thus would have taken place even in the absence of these incentives. But given the structure of executive pay, the possibility that risk-taking was influenced by these incentives should be taken seriously.
The need to reform pay structures is not, as many have claimed, simply a politically convenient sideshow. … To understand what has happened, and what lessons should be drawn, it is important to get the facts right. In contrast to what has been thus far largely assumed, the executives were richly rewarded for, not financially devastated by, their leadership of their banks during this decade.
It doesn’t really matter whether executive compensation structures caused or contributed to the crisis or not. If the manner in which executives are paid creates perverse incentives and distorts decisions away from the best interests of shareholders, as it appears to do, then both the level and structure of the compensation should be fixed.
Originally published at Economist’s View and reproduced here with the author’s permission.
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