Regulating executive compensation as a way of enhancing corporate governance after the financial crisis .

Abstract

Compensation structure for the top managers in banking sector, and precisely in broker-dealer firms (compared to traditional banks), is a key component in the corporate governance structures of firms. This Wall Street bonus culture existed for decades; however it had a tremendous amount of public backlash after the 2008 global financial system meltdown. Throughout the country, the anger at bankers was palpable. This was not a narrow populist phenomenon; rather, it reflects widespread mistrust in the nation’s financial institutions. (I Hate Banks ‘ yields 70,000 Google Index results). Many observers believe that top-level executive compensation is not sufficiently linked to long-term corporate governance. The debate about banking bonuses surfaced in early 2009, with the United States still enmeshed in the financial crisis, reports said that Wall Street bankers were set to receive nearly $20 billion in bonuses for 2008 performance. Bailout-recipient like Merrill Lynch paid nearly $4 billion in year-end bonuses just before its acquisition by Bank of America, American International Group (AIG) was about to pay $168 million ‘retention bonuses’ to its executives. Receiving bonuses even though the companies were doing poorly and the stock prices were plummeting led to the beliefs amid politicians and public that those bonuses may be the root cause of the crisis. Executives pay and incentives have been carefully scrutinized by the public even before the last financial crisis, especially after the bursting of the dotcom bubble in 2000 and the ensuing corporate scandals triggered a collapse of well-known companies such as Enron, WorldCom, and other important U.S corporations. Newspapers give much more importance to CEO compensations. Reports of salaries, bonuses, profits from selling stock options of the highest paid executives often made the headlines suggesting excessive levels of pay or a very weak relation of pay and performance. Even academic economists have been studying long ago the issues and mechanisms that can lead to an exact measurement of executive compensation package which appeared to be a very difficult and complicated task. The aim of this paper is to provide a general and theoretical review of CEO compensation debate that appeared in the wake of the last financial crisis. This debate in reality was about flawed corporate governance practices that might lead to the recession. As executives’ salaries is a major component in these practices, in addition to the large public and media attention given to this aspect. This debate mainly was about to find the real contribution of Generous compensation packages in the crisis, and then to propose reforms and regulations to solve this dilemma and to prevent similar irregularities in the future. We will try to explore briefly all the aspects related to this topic. The paper is divided into two sections; the first one contains an overview of CEO compensation from designing the perfect pay package to the importance and arguments supporting the excessive and generous bonuses, and then we’ll try to trace the changes in size of this pay in the U.S.A through the time. The second section focus on the debate that surfaced in the U.S political, academic, and populist press circles about the real contribution of these ‘obscene’ pay packages into the 2008 financial crisis. The debate is divided into three subsections: the first contains a brief review of the crisis; the second discuss the possible contribution of CEO compensation in the crisis, and in the last one we’ll try to investigate the effects of U.S regulations on the CEO bonuses. As mentioned before, the discussion in this paper take for example the case of the U.S financial system considered its development (CEO compensation practices) and because it was the starting point of the crisis. We won’t go a lot through a detailed description and discussion of all the theories and arguments that investigate for instance the optimal pay structure, or the causes of its changes. We’ll try to convey the whole debate in a short and concise presentation.