“It is now widely accepted that compensation structures in financial firms should be devised to avoid excessive incentives for risk-taking and that doing so requires tying executive compensation to long-term results and preventing cashing out of large amounts of compensation on the basis of short-term results,” writes Lucian Bebchuk,
What long-term “results” are we talking about though? We propose that risk-taking incentives could be improved by tying executives’ pay not only to the long-term payoffs of shareholders but also to those of preferred shareholders, bondholders and taxpayers insuring depositors.
In examining how executive compensation can affect risk-taking in financial firms, attention has focused on distortions that can arise from the ability of executives to cash out large amounts of compensation before the long-term consequences of risk-taking are realized. The importance of eliminating such distortions, which was first highlighted in a book, “Pay without Performance,” that one of us published with Jesse Fried five years ago, has become widely accepted in the aftermath of the financial crisis.
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