Tuesday, April 26, 2011

Short-term Compensation and Banking Failure


Short-term Compensation and Banking Failure

A study of stock option transactions reveals a link between the financial institutions most battered by the crisis and sales of shares by CEOs and other executives.

Title: Bank Executive Compensation and Capital Requirements Reform (PDF)
Authors: Sanjai Bhagat (University of Colorado at Boulder) and Brian Bolton (University of New Hampshire)

"This paper represents the analysis of billions of dollars’ worth of stock trades made by the CEOs of some of the top financial institutions in the U.S. in the years leading up to the 2008 economic crisis. Highly lucrative compensation programs encouraged many of the CEOs to sell their company stock, researchers found, raising the possibility that higher sales were associated with greater levels of imprudent risk-taking.

"…the study focused on the CEOs’ buys and sells of company stock in the eight years before the downturn. During this period, the CEOs collectively exercised stock options 470 times, purchasing a total of US$1.66 billion in shares. They made direct purchases on their own 73 times, for $36 million. But they sold their shares nearly 30 times as often — on 2,048 occasions. Overall, the sales came to $3.47 billion, netting them $1.77 billion after the cost of their options and direct purchases was subtracted. That works out to almost $16 million per year, on average, for each of the CEOs. They also received cash compensation of $891 million during these years, or another $8 million annually, on average.

"… The problem with all this, according to the researchers, is that many executive compensation programs allow top managers to own significant amounts of vested shares and options while they are still on the job and making decisions that affect company strategy and risk levels. In the run-up to the financial crisis, some of the CEOs made an abnormally high number of trades, the researchers reported, indicating a deep lack of confidence in their own firm’s future. Indeed, the researchers concluded, some CEOs were acting as if they knew that the performance of their institution could decline precipitously and were pulling their money out while they could.

"…If the trading levels before the crisis had been normal, the researchers said, it would have implied that the CEOs did not know that serious trouble was looming. In that case, the executives could have been seen as diligently working in tandem with the interests of their long-term shareholders and as being taken by surprise by 'unforeseen risks' in investments and trading strategies that plunged the institutions into crisis."


[Ed. - Over and over, we see that a primary cause for the "economic crisis" was the absence of "moral hazard" and/or meaningful consequences for violators.]

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