Sunday, September 27, 2009

Executive Compensation and the Crisis

Rene Stulz has a new working paper which studies the impact of CEO pay on the economic crisis. Studying CEO. The conclusions are interesting:
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.
This is an important study. Perhaps it is not all that surprising, since competition across banks in an asset bubble leads to herding behavior.

This article in the New York Times discusses the controversy. This study is not going to head off reforms on CEO pay. Still, it is important to think about unintended consequences:

“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.”

He points out that in 2006, a collateralized-debt obligation with a triple-A rating didn’t look like a huge risk. “On the contrary, it looked like an extremely low-risk asset,” he says. “Yet, banks incurred extremely large losses on such C.D.O.’s.”

Regulations that would have encouraged executives to take on less risk, he adds, might have made matters worse because executives “might well have chosen to invest even more in AAA-rated C.D.O.’s and other asset-backed securities.”

One could argue, I suppose, that if CEO pay has a common structure, then differences in CEO schemes may not show up in differences in importance, yet the structure is still problematic. That is, all CEO incentive packages could induce risk taking, the differences being less important than the structure itself.

1 comment:

marry said...

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