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Editor’s Note: This post is the written testimony (with footnotes omitted) submitted by Professor Lucian Bebchuk to the Committee on Financial Services, United States House of Representatives. Professor Bebchuk will be testifying today in the hearing on “Compensation in the Financial Industry.” The hearing will begin today at 10 a.m., and information about it and a link to a webcast of it can be found here. Professor Bebchuk’s complete written testimony (including footnotes) can be found here.

Chairman Frank, Ranking Member Bachus, and distinguished members of the Committee, thank you very much for inviting me to testify today.

Below I provide a brief account of some of the key issues facing us in examining compensation in the financial industry. My views on some of these issues are provided in more detail in the following three research papers from which this written testimony draws:

  • The Wages of Failure: Executive Compensation at Bear Stearns and Lehman 2000-2008 (with Alma Cohen and Holger Spamann)
    Harvard Law and Economics Discussion Paper No. 657, (December 2009).
    Forthcoming, Yale Journal on Regulation (2010).
    Available at SSRN: http://ssrn.com/abstract=1513522
  • Paying for Long-Term Performance (with Jesse Fried)
    Harvard Law and Economics Discussion Paper No. 658 (December 2009).
    Available at SSRN: http://ssrn.com/abstract=1535355
  • Regulating Bankers’ Pay (with Holger Spamann)
    Harvard Law and Economics Discussion Paper No. 641 (October 2009).
    Forthcoming, Georgetown Law Journal (2010).
    Available at SSRN: http://ssrn.com/abstract=1410072

Incentives for Risk-Taking

Standard compensation arrangements in publicly traded firms have rewarded executives for short-term results even when these results were subsequently reversed. Such arrangements have provided executives with excessive incentives to focus on short-term results. This problem, first highlighted in a book and accompanying articles that Jesse Fried and I published five years ago,2 has become widely recognized in the aftermath of the financial crisis. In financial firms, where risk-taking decisions are especially important, rewards for short-term results provide executives with incentives to improve such results even at the risk of an implosion later on.

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