Follow the Money: Compensation, Risk, and the Financial Crisis

6 Pages Posted: 8 Sep 2014

See all articles by David F. Larcker

David F. Larcker

Stanford University - Graduate School of Business

Gaizka Ormazabal

University of Navarra, IESE Business School

Brian Tayan

Stanford University - Graduate School of Business

Daniel J. Taylor

Wharton School, University of Pennsylvania

Date Written: September 8, 2014

Abstract

This Closer Look illustrates the relation between executive compensation and organizational risk through the context of the financial crisis of 2008. We demonstrate that the incentives that bankers had to increase firm risk not only increased but increased substantially in the years preceding the financial crisis.

We ask:

• How well do boards understand the relation between compensation and risk? • How much attention do directors pay to the risk-taking incentives provided by CEO wealth? • Do boards consider the relation between incentives and the risk tolerance of the firm? • How much risk should an executive be encouraged to take?

The Closer Look series is a collection of short case studies through which we explore topics, issues, and controversies in corporate governance. In each study, we take a targeted look at a specific issue that is relevant to the current debate on governance and explain why it is so important. Larcker and Tayan are co-authors of the books Corporate Governance Matters and A Real Look at Real World Corporate Governance.

Keywords: 2008 financial crisis, risk-taking incentives, executive compensation, board of directors risk oversight, risk tolerance, financial incentives, corporate governance

JEL Classification: G14, G20, G28, G30, K2

Suggested Citation

Larcker, David F. and Ormazabal, Gaizka and Tayan, Brian and Taylor, Daniel, Follow the Money: Compensation, Risk, and the Financial Crisis (September 8, 2014). Rock Center for Corporate Governance at Stanford University Closer Look Series: Topics, Issues and Controversies in Corporate Governance No. CGRP-43; Stanford University Graduate School of Business Research Paper No. 14-34. Available at SSRN: https://ssrn.com/abstract=2493398 or http://dx.doi.org/10.2139/ssrn.2493398

David F. Larcker (Contact Author)

Stanford University - Graduate School of Business ( email )

Graduate School of Business
518 Memorial Way
Stanford, CA 94305-5015
United States
650-725-6159 (Phone)

Gaizka Ormazabal

University of Navarra, IESE Business School ( email )

Avenida Pearson 21
Barcelona, 08034
Spain

Brian Tayan

Stanford University - Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

Daniel Taylor

Wharton School, University of Pennsylvania ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

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