The Squam Lake Report: Fixing the Financial System

By Kenneth R. French; Martin N. Baily et al. | Go to book overview

Chapter 6
Regulation of Executive Compensation in
Financial Services

Many people argue that inappropriate compensation policies in financial companies contributed to the World Financial Crisis. Some say the overall level of pay was too high. Others criticize the structure of pay, claiming that contracts for CEOs, traders, and other key professionals induced them to pursue excessively risky and short-term strategies.

In this chapter, we first argue that governments should generally not regulate the level of executive compensation in financial institutions.1 We have seen no convincing evidence that high levels of compensation in financial companies are inherently risky for the companies themselves or the overall economy. Moreover, limits on pay are likely to cause unintended consequences. As a result, society is better off if compensation levels are set by market forces.

The structure of executive compensation, however, can affect the risk of systemically important financial institutions. Robust financial institutions promote economic growth and employment. As we saw in the Crisis, this often causes governments to intervene when their financial systems are threatened. The result is privatized gains and

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