Bank Executive Compensation

on Sep 28 in Financial Market tagged by Trevor Hicks

The New York Times has a nice survey article on the academic and political discussion about the level of contribution that faulty pay schemes for banking executives had towards the crash. The ‘reform’ discussion has focused on the quite reasonable desire to discourage excessive risk taking, though I still question whether that is the proper prerogative of government. But I think the article nails the fundamental flaw in that attempt:

And he says there is little evidence that compensation reform would have helped head off the crisis. For example, he says, “neither bank C.E.O.’s nor regulators thought that banks were taking excessive risks.” So if the risks were viewed as small, he adds, “compensation incentives would not induce them to avoid those risks.”

The ‘he’ the article refers to is Dr. Rene Stulz of Ohio State who co-authored a study on the crisis and the role that pay schemes may have played in causing it.  What he’s pointing out in that quote is the fact that the securities that caused all the trouble were AAA rated. The CEOs just didn’t really understand what they had on their books. The article also notes that the CEOs of Bear Stearns and Lehman also lost about $1 billion each when their firms crashed so it’s not like they escaped unscathed.

What I’m worried about is Congressional action that merely caps pay at arbitrary levels for people working in banks as an appeal to the public’s preference for populist and punitive measures. We already see a drain of the best talent from government jobs to the private sector because of pay discrepancies, this would cause further talent and capital migration from public banks to privately held and less-regulated entities such as private equity and hedge funds. Or the people and capital could simply go elsewhere, offshore. If you believe that being a thriving center of international finance is bad for your country then you would probably celebrate these changes, otherwise you might be concerned about these consequences.