In the wake of the global financial crisis, attention has often focused on whether incentives generated by bank executives? compensation programs led to excessive risk-taking.
Post-crisis, compensation reform proposals have taken broadly three approaches: long-term deferred equity incentive compensation, mandatory bonus clawbacks upon accounting restatements and financial losses, and debt-based compensation. In earlier articles we recommended the following compensation
structure for bank executives: incentive compensation should consist only of restricted stock and restricted stock options ? restricted in the sense that the executive cannot sell the shares or exercise the options for two to four years after his or her last day in office. We contend that this incentive compensation package, which we term the Restricted Equity proposal, will focus bank managers? attention on the long-run and discourage them from investing in high-risk, value-destroying
projects. Equity based incentive programs such as our proposal may lose effectiveness in motivating managers to enhance shareholder value as a bank?s equity value approaches zero. As a consequence, some commentators have called for pay packages linked to bank debt. We contend, however, that the more appropriate approach is to retain equity-based incentive pay and to reform bank capital structure to reduce the probability of a tail event, and hence insolvency.
We advance two approaches, not necessarily exclusive, that coupled with the Restricted Equity proposal, we maintain, would incentivize bank executives to not take on projects of excessive risk: meaningful higher and simpler capital requirements and mandatory issuance of contingent convertible capital ? debt that converts to equity under specified adverse states of the world. Because the optimal capital level is unknown, we further advocate facilitating regulatory diversity within the international financial regulatory regime, to generate information concerning what level and form of capital works best, which would improve the quality of decision-making and the resiliency of the global financial system.
We analyze compensation design in banks. Specifically, we document associations with firm characteristics, time-series trends, pay-for-performance sensitivities, performance based pay, and the sensitivity of firm-related wealth to changes in...Read more
This paper provides a brief assessment of how ethics, culture and corporate governance have evolved in banking since the financial crisis. It concludes that we need to strengthen capital ratios and equity governance in banking to improve ethics...Read more
This paper examines the effect of disclosure regulation on the takeover market. We study the implementation of a recent European regulation that imposes tighter disclosure requirements regarding the financial and ownership information on public...Read more
This article surveys the recent literature on boards of directors and the interplay between director incentives and CEO incentives. The primary focus is on how the incentives and other characteristics of directors, boards and CEOs interact to...Read more