The collapse of Bear Stearns and Lehman Brothers in 2008 has triggered debates on the role of executive compensations in inducing risk-taking behavior. The implication is far-reaching given that executive pay reforms have been proposed to prevent another financial crisis.
A 2009 study from researchers at Harvard University and Tel Aviv University, “The Wages of Failure: Executive Compensation at Bear Stearns and Lehman 2000-2008,” shows that the companies’ pay arrangements provided considerable incentives for their executives to take excessive risks.
The study finds that:
- Between 2000 and 2008, the top executive teams of Bear Stearns and Lehman Brothers earned about $1.4 billion and $1 billion respectively from cash bonuses and equity sales. These cash flows far exceeded the value of the executives’ initial holdings at the beginning of the period.
- The executives did not sell off all their shareholdings in 2007 suggesting that they did not anticipate the firms’ imminent bankruptcies.
- Although there is a possibility that the executives decisions could be due to their failure in recognizing risks, the role of their pay arrangements in influencing excessive risk-taking behavior cannot be dismissed.
The authors conclude by proposing for reforms to encourage executives to place more weight on long-term stock prices. An example would be to impose limits on executives’ sales of options and shares.
Tags: economy, ethics, financial crisis, law