Edited by Randall S. Thomas and Jennifer G. Hill
Chapter 6: Bankers’ Compensation and Prudential Supervision: The International Principles
Guido Ferrarini 1 INTRODUCTION In the quest for possible causes of the recent financial crisis, commentators often argue that bank executives had poor incentives.1 Critics claim, in particular, that executive compensation was not properly aligned with long-term performance (Bebchuk and Fried 2010; Posner 2009), while regulators seek ways to change practices in order to restore this alignment. At least two questions arise with respect to incentives practices. The first is whether executive compensation at banks before the crisis was predominantly short-term oriented. Academics and politicians answer this question differently. The latter argue, with the support of the media, that widespread short-term incentives to bank managers were at the root of the recent crisis. On the academic side of the current debate, recent empirical studies reveal no proof that short-term incentives led to excessive risks. In particular, an empirical study examined in section 2 of this chapter shows that, in the United States at least, pay was generally aligned with the long-term interest of shareholders (Fahlenbrach and Stulz 2010). Similar studies are not available for Europe because data needed to calculate the value of stock options and long-term incentives is generally not publicly available.2 The second question, which is further analyzed in section 2, is whether banking regulation should cover compensation arrangements, either by mandating pay structures or by requiring their adjustment in order to avoid excessive risk taking. I submit that regulators should not replace boards in setting pay structures and that regulatory intervention concerning executive pay at banks should...
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