Executive Compensation in Imperfect Financial Markets
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Executive Compensation in Imperfect Financial Markets

  • Elgar Financial Law series

Jay Cullen

This important book discusses the issue of executive compensation in Anglo-American financial markets following the financial crisis. The book begins by contextualizing the problem facing financial institutions in the US and the UK and argues that approaches to government and compensation reform are flawed. It then goes on to offer solutions and suggests that new reforms to executive compensation in financial institutions would be very welcome, despite certain limitations.
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Chapter 7: Reconstituting executive compensation at financial institutions: proposals for reform

Jay Cullen

Extract

The previous chapter outlined the reforms to bank compensation made in each of the major Western financial centres. Characterising the tenor of this reform, Coffee notes that there were two major drivers of the legislative programme following the GFC, namely: (1) that the 2008 financial crisis was in substantial part the consequence of flawed executive compensation formulas that gave senior financial managers at major financial institutions perverse incentives to pursue short-term profits by accepting risk and high leverage; and (2) that the market’s perception that some financial institutions were ‘too big to fail’ enabled these firms to obtain capital at a discounted price commensurate with the market’s judgment that they would be bailed out. This discount in turn encouraged these firms to take on excessive leverage. This simple statement encapsulates the motivations underpinning the agenda for reform in the US, UK and EU following the GFC charted in the previous chapter, which will inform the proposals advanced in this chapter. These reforms of course include the introduction of several safeguards to improve the structure of executive compensation in order to focus executives’ minds on planning for medium-to-long-term shareholder value. As one would expect from such lengthy processes of planning and implementation, these measures do to some extent address the various issues which fracture the utility of current performance-based compensation calculations, and some of the reforms therefore represent strong progress in this area.

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