In Corporate Governance after the Financial Crisis
... regulators and some commentators identified executive compensation schemes that focused bank managers on short-term returns to shareholders as a causal factor in the financial crisis of 2007-2008.[1] As we have also seen, shareholder activists long have complained that these schemes provide pay without performance. This was one of the corporate governance flaws Dodd-Frank was intended to address, most notably via say on pay.
The trouble, of course, is that shareholders and society do not have the same goals when it comes to executive pay. Society wants managers to be more risk averse. Shareholders want them to be less risk averse. If say on pay and other shareholder empowerment provisions of Dodd-Frank succeed, manager and shareholder interests will be further aligned, which will encourage the former to undertake higher risks in the search for higher returns to shareholders.[2] Accordingly, as Christopher Bruner aptly observed, “the shareholder-empowerment position appears self-contradictory, essentially amounting to the claim that we must give shareholders more power because managers left to the themselves have excessively focused on the shareholders’ interests.”[3]
Now there's additional evidence that sharehjolder empowerment is dangerous, at least for banks. From Ferreira, Daniel, Kershaw, David, Kirchmaier, Tom and Schuster, Edmund-Philipp, Shareholder Empowerment and Bank Bailouts (November 2, 2012). Available at SSRN: http://ssrn.com/abstract=2170392:
We investigate the hypothesis that shareholder empowerment may have led to more bank bailouts during the recent financial crisis. To test this hypothesis, we propose a management insulation index based on banks’ charter and by-law provisions and on the provisions of the applicable state corporate law that make it difficult for shareholders to oust a firm’s management. Our index is both conceptually and practically different from the existing alternatives. In a sample of US commercial banks, we show that management insulation is a good predictor of bank bailouts: banks in which managers are fully insulated from shareholders are roughly 19 to 26 percentage points less likely to be bailed out. We also find that banks in which the management insulation index was reduced between 2003 and 2006 are more likely to be bailed out. We discuss alternative interpretations of the evidence. The evidence is mostly consistent with the hypothesis that banks in which shareholders were more empowered performed poorly during the crisis.
Somehow, however, I don't expect the apologists for shareholder empowerment to admit their error anymore than I expect the apologists for turning corporate governance over to the SEC to admit theirs.
[1] Mülbert, supra note 322, at 8
[2] See Carl R. Chen et al., Does Stock Option- Based Executive Compensation Induce Risk-Taking? An Analysis of the Banking Industry, 30 J. Banking & Fin. 915, 943 (2006) (arguing that the structure of executive compensation in the banking industry pre-crisis induced risk taking by managers); Kose John & Yiming Qian, Incentive Features in CEO Compensation in the Banking Industry, FRBNY Econ. Pol’y Rev., Apr., 2003, at 109 (arguing that if executive compensation induces the interests of managers to “closely aligned with equity interests in banks, which are highly leveraged institutions, management will have strong incentives to undertake high-risk investments”).
[3] Christopher M. Bruner, Corporate Governance in a Time of Crisis 13 (2010), http://ssrn.com/abstract=1617890.
