Compensation practices vs. financial crisis
Executive compensation is directly linked to the financial crisis. Some characteristics should have rejected short-term decision making and disproportionate risk-taking (Narayanan, Ferri, & Brem, 2010). Stock and equity options presented to the bankers, for example, guaranteed that if the market value of a company dramatically dropped, an identical outcome would be witnessed in the salary of senior management (Chen, Huang, & Wei, 2014).
The crisis affected some organizations more than others because both features of bank remuneration have become the emphasis of improved directives projected to stop senior bank management from taking excessive risks. Executive remuneration schemes improved instant income generation using a judicious continuing evaluation of credit risk (Gregg, Jewell, & Tonks, 2011). The situation also involved mortgage lending, and numerous bonuses brought up the complications that were not expected.
The committees in financial institutions involved in the credit crisis should have assessed the perils of excessive risk-taking. By doing this, they would be able to develop and implement directives that can hold back uncontrolled risk-taking without taking away banks’ capability to recompense genuine performance (Gawande, Hoekman, & Cui, 2014).
Risk-taking incentives
Risk-taking incentives took an important role in the credit crisis. Their role can be explained by the compensations that explicitly generated excessive risk-taking. It is only reasonable that banks want rewards that motivate enduring performance, reject unnecessary risk-taking, and correctly associate risk with reward (Conyon, Fernandes, Ferreira, Pedro, & Murphy, 2013). Nonetheless, a better administrative configuration aimed to connect incentives and stockholder interests would have led to robust risk-taking incentives in the majority of economic institutions.
The assessment of incentives throughout the crisis could expose the negative effects of pay packages and adverse insights of vagueness all through the crisis. Bearing this in mind, one should still consider the risk-taking an inherent part of the US economy. The boards should act as supervisors for the management and focus on long-term objectives instead of letting managers take excessive risks (Conyon et al., 2013). In this case, asymmetric option awards can be considered an implicit incentive to take excessive risk. The boards should limit decision-making entrenchment and increase the level of board independence.
Risk management issues
The expenses contingent on poor decision-making throughout the crisis were very high (Narayanan et al., 2010). This meant that newly revised methods would be profitable for the industry. Moreover, this kind of novelty certified that the gathering of the data required to implement this transformation would be excessively expensive (Narayanan et al., 2010). This new directive had an exclusive toolkit and a prospect to generate major improvements in the system.
The problem with the previous system was that risk managers were on the verge of becoming gradually helpless and ineffective when the banks got stuck in a tight situation (Narayanan et al., 2010). The agents were motivated to take unpredictable risks, so they could make profits that seemed to come from their superior skills (Gregg et al., 2011). The superior remuneration revenues from originating perilous, weak loans fed straight to the originating unit’s outcomes. Regardless, this remuneration revenue was, to some extent, a reward for the serious risk of being stuck with unsold havens as it turned out that the market environment changed.
Long-term performance tools
Grant-based and aggregate limitations became the main tools used to ensure that executive pay was more closely tied to long-term performance. The main problem, in this case, was whether a senior manager’s incentives were enhanced by necessitating him or her to possess an equity grant for a certain period, even if that certain period might encompass her or his withdrawal (Narayanan et al., 2010). The answer to this inquiry should be positive.
Demanding from the retiring senior manager to hold his or her stocks up until the definite date would both eliminate any incentive for the directors to fast-track their withdrawal and make it less expected that the manager will concentrate on short-range consequences while making decisions for the company right before their retirement (Narayanan et al., 2010). Consequently, the boards should not promote deferred bonus plans but link the company’s performance to post-termination payouts. The company should grant acceleration upon termination as a way to show commitment to its employees.
Board’s reaction to public sentiment
For the majority of the companies, public opinion is recurrently considered to be a disciplining instrument for business decisions. It is important to realize that public sentiment outlines the key characteristics of corporate governance (Narayanan et al., 2010). For instance, it takes into consideration the treatment of sectional stockholders or board individuality, and it is a central asset in recognition of commercial scams.
If we speak about executive pay, many experts state that public scandals may condense compensations allocated to company CEOs. Corporate efforts to self-regulate would include several options. The most probable selection suggests that businesses may cover-up their executive compensations by turning them into top-secret data (Narayanan et al., 2010). This type of business information is stereotypically not scrutinized by the press and media. In other words, this would let the business evade public attention and significantly reduce the risk of further and broader regulatory interventions on executive pay.
Shareholder approval
Currently, shareholders witness the fact that the payments that go to senior management, and CEOs are rather massive (Azim & Ahmmod, 2014). This situation also offers significant evidence when it comes to the comparison of directors’ and stockholders’ interests. The misunderstandings may cost a lot. In case if the say-on-pay directive becomes a reality, the option that might help boards win shareholder approval includes providing the shareholders with important information concerning the efficiency of a board’s self-regulating oversight (Azim & Ahmmod, 2014).
If directors cannot refuse CEO payments, they possibly cannot reject a poorly premeditated tactic or prevent operational letdowns. The board should carefully approach the stakeholders and provide them with relevant data concerning necessary (but adequate) remunerations. The board should also prove its self-governance to guarantee upcoming revenues and minimize the occurrence of failures (Azim & Ahmmod, 2014).
Boards vs. legislators
The executives’ incentives to make high-risk decisions may be defined not by the dissimilarity between directors’ and stockholders’ interests but, on the contrary, by the incentives that stakeholders themselves have to make the decisions that involve risk-based outcomes. In reality, bank stockholders may be motivated to upsurge the risk of bank resources to the detriment of investors and debtholders as a consequence of a mixture of partial legal responsibility, high level of control, and implied government agreements.
Taking into consideration all of these incentives and restrictions, the board of directors should provide adequate remuneration data to the shareholders. The latter, in turn, should guarantee satisfactory conditions for the board and apply the say-on-pay directive more often. These actions would help restore confidence in US companies and revive the economy.
References
Azim, M., & Ahmmod, S. M. (2014). Executive remuneration, financial crisis and ‘Say on Pay’ rule. Journal of International Business and Economics JIBE, 2(4), 2-14. Web.
Chen, Z., Huang, Y., & Wei, K. C. (2014). Executive pay disparity and the cost of equity capital. SSRN Electronic Journal, 2(14), 33-51. Web.
Conyon, M. J., Fernandes, N., Ferreira, M. A., Pedro, M., & Murphy, K. J. (2013). Banking bonuses and the financial crisis. A Transatlantic Perspective, 3(11), 65-99. Web.
Gawande, K., Hoekman, B., & Cui, Y. (2014). Global supply chains and trade policy responses to the 2008 crisis. The World Bank Economic Review, 29(1), 102-128. Web.
Gregg, P., Jewell, S., & Tonks, I. (2011). Executive pay and performance: Did bankers’ bonuses cause the crisis? International Review of Finance, 12(1), 89-122. Web.
Narayanan, V. G., Ferri, F., & Brem, L. (2010). Executive Pay and the Credit Crisis of 2008. Harvard Business Journal, 9(109), 1-12.