Should Wall Street Executive Pay Be Regulated

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It is difficult to deny that investment banking executive compensation is short-term incentivised and is highly related to individual performance. This pay structure effects managers’ behavior by pushing them to achieve more, but also by providing them with greater incentives to take additional risk with limited liability. This skewed incentives played an important role in stimulating the global financial crisis. Motivated to increase their personal pay, managers exposed shareholders to significant losses by engaging in gambling in order to manipulate their performance results.

Increased executive compensation during the crisis resulted in rising economic inequality with top earners taking home even bigger paychecks while average employee income has deteriorated (quote here). Also, when taking inappropriate risk, trying to inflate their compensation, bankers further contributed to rapidly increasing volatility of the financial services industry and its credit bubble. In addition to improper incentives (individual vs. team pay for performance and short-term vs. long-term targets), there have been some high-profile examples in the recent years of corporate governance failure due to corrupted boards of directors.

This happens when top executives’ performance is not connected to compensation; managers design their own pay packages and control the board by bribing directors with deals, such as access to private jets, for example. Lucian Bebchuk and Jesse Fried, authors of the 2004 book “Pay Without Performance”, conclude that “flawed compensation arrangements have not been limited to a small number of ‘bad apples’; they have been widespread, persistent, and systematic.” In light of the recent global financial crisis, should regulations be put in place for executive compensation in the financial service industry in order to decrease the growing gap between rich and poor? Some Arguments in favour of regulations are as follows:

•Given current slow moving economy, boards should cap executives’ bonuses and options. Freed up funds should be reallocated to lower level employees in the form of raises. This will decrease income inequality by creating a middle class that in turns will stimulate the economy.

•The rules and regulations in regards to bankers’ compensation are needed because when excessive risk is taken by top executives, American banks bailouts and deposit insurance shortfalls are funded with taxpayers’ money.

•When banks lose money, shareholders and public insurance agencies are affected the most. Because executives’ liability is limited, it creates incentive for them to take on additional risk and act in their personal interests, not in the best interests of the company’s shareholders. Regulations can help align the interest of executives and shareholders by decreasing incentives for inappropriate risk taking.

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