Regulating Bankers’ Pay
Lucian Bebchuk and Holger Spamann
Harvard Law School
Law and Economics Workshop, November 3, 2009
. The financial crisis has raised concerns that executive
pay in financial firms can produce excessive incentives
for risk-taking. Firms and authorities around the world
seek to address these concerns.
. The G-20 leaders committed “to implement strong
international compensation standards aimed at ending
practices that lead to excessive risk- taking” (Pittsburg
Meeting, September 2009).
. How can executive pay in financial firms produce such
incentives? What can/should be done about it?
z We analyze a distortion that produces
excessive risk-taking incentives that has
received little attention.
z Show that corporate governance reforms
aimed at aligning pay arrangements with
shareholders’ interests cannot eliminate this
z Develop a case for regulation of bankers’ pay
and analyze how regulators should monitor
and regulate such pay.
The Short-term Distortion
z One major factor that has induced excessive risk-taking is
that firms’ standard pay arrangements reward executives
for short-term gains even when these gains are
In the aftermath of the financial crisis, this distortion (first
highlighted in Bebchuk-Fried, Pay without Performance
(2004)) has become widely recognized.
z We identify a separate distortion – one that would exist
even in a one-period model world in which no short-term
distortions could exist.
The Leverage Problem
In addition to the short-termism problem, there was a second
important source of incentives to take excessive risks that has
received insufficient attention: Executives’ payoffs were tied to
highly leveraged bets on the value of financial firms’ capital.
z Compensation arrangements tied executives’ interests to the
value of common shares in financial firms or even to the value
of options on such shares
z => executives not exposed to the potential negative