* "Bank CEO Incentives and the Credit Crisis;' by Rudiger Fahlenbrach and Rene M. Stulz. August 2010. SSRN #1439859.
* "Executive Compensation and Corporate Governance in Financial Firms: The Case for Convertible Equity-Based Pay;' by Jeffrey N. Gordon. July 2010. SSRN #1633906.
* "Pay for Banker Performance: Structuring Executive Compensation for Risk Regulation;' by Frederick Tung. July 2010. SSRN #1647025.
What role did the incentives provided by the compensation of financial executives play in the financial crisis? Rene Stulz has demonstrated that the more equity in an executive's pay, the worse the subsequent
performance of the financial institution. The larger the stock exposure of a chief executive officer in 2006, the worse the subsequent performance of the institution in 2007 and 2008. This evidence certainly contradicts the commonly held view that bank CEOs led us off a cliff to enrich themselves and their shareholders. But the evidence is consistent with the view that the more incentivized a CEO was to take shareholder interests into account, the worse the results for those shareholders, which would seem to contradict much modern compensation theory.
Recent papers by Jeffrey Gordon of Columbia Law School and Frederick Tung of Boston University Law School argue that equity compensation is just fine for non-financial firms because such firms do not pose a systemic threat to the rest of the economy. (The political system did not have the courage to test that theory in the case of General Motors.) But it is not efficient for financial institutions whose failure induces investors to lose confidence indiscriminately in other financial institutions.
They argue that the problem arises because executives of corporations are not diversified investors. Instead, their wealth is overwhelmingly invested in the firm they manage. Thus, unlike diversified investors who face systemic risk, executives do not really face correct incentives if their decisions have large spillover effects on all other assets in the economy, because they do not own any of those assets. …