Editor’s Note: Below is the response by Professor
Lucian Bebchuk to the opening statement of Professor
René Stulz in an online debate between the two of them at a World Bank forum. The debate focused on the question: Has executive compensation contributed to the financial crisis? The moderator’s introduction to the debate is available
here; Lucian Bebchuk’s opening statement is available
here; René Stulz’s opening statement is available
here; Lucian’s Bebchuk’s response is available
here; and René Stulz’s response is available
here. Bebchuk’s response refers to two studies on the subject issued by the Harvard Law School Program on Corporate Governance,
Regulating Bankers’ Pay and
Paying for Long-Term Performance.
In his opening statement, René Stulz relies on the results of the Fahlenbrach-Stulz study (FS study) to reject the view that executive compensation has contributed to the financial crisis. Stulz argues that the evidence in his study is “inconsistent with the view that banks performed poorly because CEOs had poor incentives.” However, as explained below, the FS study does not provide a good basis for rejecting the poor incentives view.
The FS study attempts to test the “poor incentives” hypothesis by examining whether banks whose CEOs had larger equity holdings performed better during the crisis. Failing to find such an association – and indeed finding that such banks performed worse – the FS study rejects the poor incentives hypothesis. But the poor incentives view does not attribute poor risk-taking incentives to relatively low equity holdings, and the analysis in the FS study does not supply an adequate test of this view.
As I explained in my opening statement, the poor incentives view does not regard large equity holdings as the way to ensure good risk-taking incentives and does not view poor incentives as rooted in insufficient equity holdings. Rather, as I explained, poor incentives have resulted from (i) design of equity compensation (as well as bonus compensation) that rewarded executives even for short-term results that were subsequently reversed, and (ii) linking executive payoffs only to payoffs for shareholders and not also to payoffs for other contributors of capital to financial firms (such as bondholders).
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