Determination of Executive Remuneration in Banks- A Discussion in the Light of the Global Financial Crisis
- Category: Samples
The executive compensation had been a debatable topic particularly in the context of the recent global financial crisis, which emerged in 2007. Studies showed the improperly structured compensation arrangements especially the bonuses and the benefits in spite of the loss of shareholder values of the financial institutions including banks, as one main factor contributing to the recent financial crisis. In this context, this essay discusses how the executive remuneration in banks needs to be done in the light of the global financial crisis (Demirer and Yuan, 2011).
2 Executive Remuneration during Financial Crisis
Banks differ from other firms due to the determination of the liquidity producing function by the mismatch between assets and liabilities of banks balance sheets, high leverage ,opacity and interconnectedness of banks, high exposure to risk factors ,possibility of creditor runs and due to the heavy regulation and supervision(Mulbert,2010).
One the one hand, it is argued that the executive compensation, which is properly structured acts a main mode of corporate governance by aligning the interests of the managers with those of shareholders. Thus, a good side of the executive compensation in the investment and financing decisions is being projected by this set of argument (Faulkender et al, 2010).There are several incentive related components to the executive compensation like bonuses, stocks, options, severance packages and termination of job based on the performance other than the basic salaries, which in turn, act as incentives for the performance of the executives. This is supposed to result in value creation, contributing to economic growth and employment (Faulkender et al, 2010).
On the other hand, it is argued that the compensation practices, which are not well structured, can result in value destruction rather than value creation. The overemphasis on certain attributes like short term aspects can result in the executives’ ignorance of long term investments, which in turn can adversely affect the performance. Moreover in the case of firm overvaluation, stock based compensation is argued to result in earnings’ manipulation or overinvestment so that the current stock price is justified (Faulkender et al, 2010).One of the main mode of aligning managerial interests with shareholders through the compensation of executive is the linking of compensation to performance. How far this has been attained remains a debatable issue, especially in the context of the recent financial crisis.
The following tables show the salary, bonus and the option value and the from 1996 to 2007 for the highest ranked executives of the commercial banks in this period.
The figures show that remuneration trends have changed during the period of financial crisis. More specifically an upward trend in nominal salary is seen from figure 1 and stable pay in the 2000s.Figure 2 shows sharp bonus drops in 2006-07 suggesting a link between the pay and the market forces that time. Figure 3 shows the sharp rise in stock options from 2000 and thereafter significant fall. Studies show the possibility of sharp scrutiny of the stock option values as one reason for this fall as a result of the Sarbanes-Oxley act 0f 2002(Mehran etal,2011). Some studies like Fahlenbrach and Stulz (2009) obtained the firm performance in US banks as worse in spite of the high executive compensation and strong incentives at the time of financial crisis. On the other hand, the studies by Bebchuk and Spamann (2009) showed these as not necessarily the result of high compensation which was properly structured while this was the result of the rewards outweighing the risks. Thus, how far the executive compensation has been a contributor to the recent financial crisis has become a debatable issue. The design of thee executive compensation has been argued as one main factor affecting its link to the performance in this regard. Studies showed the motivation for excessive risk taking as the significant rise in equity based compensation in banks recently, which might have contributed to the recent global financial crisis(
3. Policy Responses
In response to the developments during the financial crisis, the Financial Stability Board set thee internationally recognized principles for making an end to regulate the bankers pay on September 2009(Financial Stability Board, 2009).These were applicable only to banks with assets more than $1 billion(Financial Stability Board,2009). On April 2009, European Commission recommended for remuneration policies in such a way that they need to be in compliance with effective risk management (Mulbert, 2010). In US, Title II of the Wall street and the Consumer Protection Act of 2009 were the main initiatives which made the remuneration policies stricter(Mulbert,2010).However, all these laws mainly were applicable to senior management executives whose activities had significant impact on the risk profile of banks. None of these were concrete proposals that can be motivating the executives to take moderate risk levels, as reported by studies (Landskroner and Raviv, 2010).
In this essay, the issue of executive compensation of banks in the light of the recent financial crisis and the policy responses were examined. The discussion showed the focus of executive compensation debate suddenly changing from non financial firms to that of banks in the background of the global financial crisis. Studies reported the excessive equity based compensation as the motivating factor for executive excessive risk taking in the banks. The discussion shows the need for the design of executive compensation in such a way that the executives are motivated to take only moderate level of risk. Unfortunately, the discussion shows none of the reform measures in this regard were concrete proposals which motivate the executives to take only a moderate level of risk. Thus a strong need for designing the executive compensation in the manner described above is recommended, based on the above discussion. Concrete proposals in this regard are recommended, based on the discussion here.
Bebchuk, Lucian and Holger Spamann( 2009) “Regulating Bankers’ Pay,” Harvard Law School Discussion Paper No. 641,
Demirer I and J Yuan(2011): “Executive compensation and firm performance in the U.S. restaurant industry: An agency theory approach”, viewed on February 2013 at http://scholarworks.umass.edu/cgi/viewcontent.cgi?article=1042&context=gradconf_hospitality
Fahlenbrach and Rene Stulz( 2009) “Bank CEO Incentives and the Credit Crisis,” Dice Center Working Paper 1009-13, Ohio State University.
Faulkender D, D Kadyrzhanova, N. Prabhala, and Lemma Senbe (2010): “Executive Compensation: An Overview of Research
on Corporate Practices and Proposed Reforms”, viewed on February 17,2013 at http://www.rhsmith.umd.edu/faculty/faulkender/ecomp_review.pdf,.
Financial Stability Board (2009), “Principles of Sound Compensation Practices – Implementation Standards,” viewed on February 17, 2013 at http://www.financialstabilityboard.org/list/fsb_publications/index.htm.
Landskroner Yand A Raviv(2010). “The 2007-2009 Financial Crisis and Executive Compensation: an Analysis and a Proposal for a Novel Structure”,
Mehran H,A Morrison and J Shapiro(2011): “Corporate Governance and Banks: What Have We Learned from the Financial Crisis?”,Federal Reserve Bank Report NewYork No502.
Mulbert PO(2010): “Corporate Governance of Banks after the Financial Crisis - Theory, Evidence, Reforms”,ecgi Working Paper series in Law, WP151/2010.