Bankers had cashed in before the
By Lucian Bebchuk, Alma
Cohen and Holger Spamann
Published: December 7 2009 02:00
| Last updated: December 7 2009 02:00
According to standard narrative, the meltdown
of Bear Stearns and Lehman Broth ers largely wiped out the wealth of their
top executives. Many - in the media, academia and the financial sector -
have used this account to dismiss the view that pay structures caused
excessive risk-taking and that reforming such structures is important. The
narrative, however, turns out to be incorrect.
It is true that the top executives at both
banks suffered significant losses on shares they held when their companies
collapsed. But our analysis, using data from Securities and Exchange
Commission filings, shows the banks' top five executives had cashed out such
large amounts since the beginning of this decade that, even after the
losses, their net pay-offs during this period were substantially positive.
In 2000-07, the top five executives at Bear
and Lehman pocketed cash bonuses exceeding $300m and $150m respectively
(adjusted to 2009 dollars). Although the financial results on which bonus
payments were based were sharply reversed in 2008, pay arrangements allowed
executives to keep past bonuses.
Furthermore, executives regularly took large
amounts of money off the table by unloading shares and options. Overall, in
2000-08 the top-five teams at Bear and Lehman cashed out close to $2bn in
this way: about $1.1bn at Bear and $850m at Lehman. Indeed, the teams sold
more shares during the years preceding the firms' collapse than they held
when the music stopped in 2008.
Altogether, equity sales and bonuses over
that period provided the top five at the two banks with cash of about $1.4bn
and $1bn respectively (an average of almost $250m each). These cash proceeds
considerably exceed the value of the executives' holdings at the beginning
of 2000 (which we estimate to be in the order of a respective $800m and
Of course, the executives would have made
much more had the banks not blown up. By contrast to shareholders who stuck
with the banks, however, the executives' total pay-offs during the period
were decidedly in the black.
Our analysis undermines the claims that
executives' losses on shares during the collapses establish that they did
not have incentives to take excessive risks. The fact that the executives
did not sell all the shares they could prior to the meltdown does indicate
that they did not anticipate collapse in the near future. But repeatedly
cashing in large amounts of performance-based compensation based on
short-term results did provide perverse incentives - incentives to improve
short-term results even at the cost of an excessive rise in the risk of
large losses at some (uncertain) point in the future.
To be sure, executives' risk-taking might
have been driven by a failure to recognise risks or by excessive optimism,
and thus would have taken place even in the absence of these incentives. But
given the structure of executive pay, the possibility that risk-taking was
influenced by these incentives should be taken seriously.
The need to reform pay structures is not, as
many have claimed, simply a politically convenient sideshow. Even if the
type of incentives given to executives of Bear and Lehman - and others with
similar pay structures - were not the cause of risk-taking in the past, they
could be in future. Financial institutions, and the regulators overseeing
them, should give the necessary priority to redesigning bonuses and
equity-based compensation to avoid rewarding executives for short-term
results that are subsequently reversed.
The stories of Lehman and Bear will
undoubtedly remain in the annals of financial disaster for decades to come.
To understand what has happened, and what lessons should be drawn, it is
important to get the facts right. In contrast to what has been thus far
largely assumed, the executives were richly rewarded for, not financially
devastated by, their leadership of their banks during this decade.
The writers are affiliated with Harvard
Law School's corporate governance programme, which issued their study, "The
Wages of Failure: Executive pay in Lehman and Bear Stearns 2000-2008".
Although Mr Bebchuk is a consultant to the US Treasury's office of the
special master for Tarp executive compensation, the views expressed should
not be attributed to that office