If you thought that the executives at Lehman Brothers and Bear Stearns paid dearly in when their firms famously imploded last year, think again.
A new study by three professors at the Program for Corporate Governance at Harvard Law School reexamines the "standard narrative" of the loss of wealth suffered by top leaders at Bear and Lehman. The top five executives at Bear and Lehman were able to sell billions in stock holdings from 200-2008, the study notes, while most shareholders saw their investments in the two firms decimated.
During the same period, the study notes, "the shareholder payoffs these teams produced were indisputably poor." From the study:
Overall, we estimate that the top executive teams of Bear Stearns and Lehman Brothers derived cash flows of about $1.4 billion and $1 billion respectively from cash bonuses
and equity sales during 2000-2008. These cash flows substantially exceeded the value of
the executives' initial holdings in the beginning of the period, and the executives' net
payoffs for the period were thus decidedly positive. The divergence between how the top
executives and their shareholders fared implies that it is not possible to rule out, as
standard narratives suggest, that the executives' pay arrangements provided them with
excessive risk-taking incentives.
While it's tempting to examine the paper loses suffered by execs at Bear and Lehman (Jimmy Cayne's stock holdings fell by over $900 million, for example) the report suggests that those figures may be misleading. The authors -- Lucian Bebchuck, Alma Cohen, and Holger Spamann -- assert that the fact that Bear and Lehman leaders simply lost large sums of money in the crisis, doesn't mean they weren't tempted by skewed incentives:
There can be little doubt that the banks' executives had strong reasons to prefer
that their companies survive. Furthermore, the executives' holding so many shares at the
time of the collapse indicates that they had not foreseen in 2007 or early 2008 that such a
collapse was around the corner. The important question, however, is whether the
executives had an incentive to make decisions that created an excessive risk - though by
no means certainty - of massive losses at some (uncertain) time down the road.
In particular, excessive incentives to take risks might have been generated by
executives' ability to cash out compensation based on the firms' short-term results. To
the extent that executives did cash out large amounts of such compensation, their
decisions might have been distorted by an excessive focus on short-term results. This
problem, first highlighted several years ago in a book and accompanying articles co-
authored by one of us,22 has received much attention in the wake of the crisis from both
public officials and business leaders.
The study arrives a conclusion long-held by critics of the financial industry. In short, Wall Street pay was specifically structured to encourage short-term gains:
"...the executives were the able to obtain large amounts of bonus compensation based on high earnings in the years preceding the financial crisis, but did not have to return any of those bonuses when the earnings subsequently evaporated and turned into massive losses. Such a design of bonus compensation provides executives with incentives to seek improvements in short-term earnings figures even at the cost of maintaining an excessively high risk of large losses down the road."
Interestingly, the study suggests that Wall Street's bonus culture may not be the largest cause of the excessive risks taken by the industry. Fixing compensation isn't merely an issue of increasing stock awards and limiting bonuses; in fact, the study steers clear of suggestions that pay should be capped. Instead, the study argues that the failure of Bear and Lehman suggest that compensation clawbacks should be considered.
READ the report here: