The 2007-2009 Financial Crisis and Executive Compensation: Analysis anda Proposal for a Novel Structure
During the 2007-2009 crises financial institutions have come underincreasing pressure from regulators, politicians and shareholders tochange their compensation practices in order to remove the incentive forshort term excessive risk taking. In this paper we analyze first how thecommon executive compensation, which is composed of equity-basedcompensation (stocks and executive stock options) and a fixed cashcompensation, leads to a concave relationship between assets risk andcompensation value and creates an incentive for the executive to choosecorner solutions that either lead to an excessive risk taking or to afreeze out of the lending activity to the public. This paper’smain contribution is a novel component, for executive compensation, thatis paid only if the value of the firm assets is located in somepredetermined range. This new form of compensation motivates theexecutive to take an intermediate (internal solution) level of assetsrisk because of the convex relationship between assets risk andcompensation value.
Year of publication: |
2009-06-17
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Authors: | Landskroner, Yoram ; Raviv, Alon |
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