How to Fix Bankers’ Pay

Abstract

This essay – written for a special issue of the American Academy of Arts and Sciences’ Daedalus journal on lessons from the financial crisis – discusses how bankers’ pay should be fixed. I describe two distinct sources of risk-taking incentives: first, executives’ excessive focus on short-term results; and, second, their excessive focus on results for shareholders, which corresponds to a lack of incentives for executives to consider outcomes for other contributors of capital. I discuss how pay arrangements can be reformed to address each of these problems and conclude by examining the role that government should play in bringing about the needed reforms. The essay provides an accessible summary of the analysis developed in Bebchuk and Fried, “Paying for Long-Term Performance” (University of Pennsylvania Law Review, 2010, http://ssrn.com/abstract=1535355) and Bebchuk and Spamann, “Regulating Bankers’ Pay” (Georgetown Law Journal, 2010, http://ssrn.com/abstract=1410072).

Keywords: Financial Crisis, Executive Compensation, Banking, Risk-Taking

JEL Classification: G28, K23