Did the structure of banker pay cause the crisis?

This is an old topic but it is in the headlines again, so I pass this along, from Jeff Friedman:

This “executive compensation” theory of the crisis
is now the keystone of the conventional wisdom, having been embraced by
President Obama, the leaders of France and Germany, and virtually the
entire financial press. But if anyone has evidence for the
executive-compensation thesis, they have yet to produce it. It’s a
great theory. It “makes sense”–we all know how greedy bankers are! But
is it true?

The evidence that has been produced suggests that it is false.

one thing, bankers were often compensated in stock as well as with
bonuses, and the value of this stock was wiped out because of the
investments in question. Richard Fuld of Lehman Brothers lost $1
billion this way; Sanford Weill of Citigroup lost half that amount. A
study by René Stulz and Rüdiger Fahlenbrach[3] showed that banks with
CEOs who held a lot of stock in the bank did worse
than banks with CEOs who held less stock, suggesting that the bankers
were simply ignorant of the risks their institutions were taking.
Journalists’ and insiders’ books about individual banks[4] bear out
this hypothesis: At Bear Stearns and Lehman Brothers, for example, the
decision makers did not recognize the risks until it was too late,
despite their personal investments in the banks’ stock.

The Stulz and Fahlenbrach abstract reads as follows:

investigate whether bank performance during the credit crisis of 2008
is related to CEO incentives and share ownership before the crisis and
whether CEOs reduced their equity stakes in their banks in anticipation
of the crisis. There is no evidence that banks with CEOs whose
incentives were better aligned with the interests of their shareholders
performed better during the crisis and some evidence that these banks
actually performed worse both in terms of stock returns and in terms of
accounting return on equity. Further, option compensation did not have
an adverse impact on bank performance during the crisis. Bank CEOs did
not reduce their holdings of shares in anticipation of the crisis or
during the crisis; further, there is no evidence that they hedged their
equity exposure. Consequently, they suffered extremely large wealth
losses as a result of the crisis.

It's entirely fair to argue that these tests are not decisive.  But still, the evidence isn't there — at least not yet — that executive pay was in fact the big problem.

I thank Jeff Friedman for the pointer.


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