Economics, Politics, and the International Principles for Sound Compensation Practices: An Analysis of Executive Pay at European Banks

Abstract

In this Article we submit that the compensation structures at banks before the financial crisis were not necessarily flawed and that recent reforms in this area largely reflect already existing best practices. In Part I we review recent empirical studies on corporate governance and executive pay at banks and suggest that there is no strong support for regulating bankers’ compensation structures. We also argue that detailed regulation of incentives would subtract essential decisionmaking powers from boards of directors and make compensation structures too rigid. In Part II we note that political support for regulating bankers’ pay has been strong and led to reforms promoting long-term incentives to executives on the assumption that short-term incentives were a cause of the crisis. The Financial Stability Board Principles for Sound Compensation Practices (the “Principles”) follow this trend, at the same time representing a political compromise between the various interest groups concerned. They pick up traditional compensation criteria from pre-crisis best practices, adapting them to the post-crisis setting, while leaving some flexibility in pay structures. We suggest that a certain degree of flexibility should be kept when implementing the Principles in national jurisdictions. In Part III we analyze the regulatory developments concerning executive pay at banks in Europe and find variations in the implementation of the Principles. We also show that remuneration policies at large European banks are converging towards the international Principles, while varying in the implementation of individual standards. However, recent EU reforms may change the situation considerably by imposing detailed requirements as to pay structures in the financial sector.

Keywords: Executive Remuneration, Corporate Governance, Banks, Financial Crisis, Prudential Regulation, Supervision

JEL Classification: G20, G21, G28, G30, G32, G34, G38, K22, K31, M12