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Wednesday, March 24, 2010

What Market Discipline?

How much did executives at Bear Stearns and Lehman Brothers lose as a result of the financial crisis?:

Paid to Fail, by Lucian Bebchuk, Alma Cohen, and Holger Spamann, Commentary, Project Syndicate: ...Lehman’s executives made deliberate decisions to pursue an aggressive investment strategy, take on greater risks, and substantially increase leverage. Were these decisions the result of hubris and errors in judgment or the product of flawed incentives?
After Bear Stearns and Lehman Brothers melted down, ushering in a worldwide crisis, media reports largely assumed that the wealth of these firms’ executives was wiped out, together with that of the firms they navigated into disaster. This “standard narrative” led commentators to downplay the role of flawed compensation arrangements and the importance of reforming the structures of executive pay.
In our study, “The Wages of Failure: Executive Compensation at Bear Stearns and Lehman Brothers 2000-2008,” we examine this standard narrative and find it to be incorrect. We ... find that,... during 2000-2008, the top five executives at Bear Stearns and Lehman pocketed about $1.4 billion and $1 billion, respectively, or roughly $250 million per executive. These cash proceeds are substantially higher than the value of the holdings that the executives held at the beginning of the period. Thus, while the long-term shareholders in their firms were largely decimated, the executives’ performance-based compensation kept them in positive territory.
The divergence between how top executives and their companies’ shareholders fared raises a serious concern that the aggressive risk-taking at Bear Stearns and Lehman – and other financial firms with similar pay arrangements – could have been the product of flawed incentives. ...
It is important for financial firms – and firms in general – to reform compensation structures to ensure tighter alignment between executive payoffs and long-term results. ...
Had such compensation structures been in place at Bear Stearns and Lehman, their top executives would not have been able to derive such large amounts of performance-based compensation for managing the firms in the years leading up to their collapse. This would have significantly reduced the executives’ incentives to engage in risk-taking.
Indeed,... comprehensive and robust reform of pay structures ... could do a great deal to improve incentives and prevent the type of excessive risk-taking that firms encouraged in the years preceding the financial crisis... Reforms that redress these destructive incentives should stand as an important lesson and legacy of Bear Stearns, Lehman Brothers, and the crisis they helped to fuel.

    Posted by on Wednesday, March 24, 2010 at 01:20 AM in Economics, Market Failure | Permalink  Comments (23)


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