I'm broadly in agreement with Erik Gerding's take:
If we are justifying regulating compensation because of the crisis, it seems odd to sweep in non-financial firms. What, after all, does the pay of executives at Intel, Google, Boeing, or Exxon Mobil have to do with the financial crisis? Say-on-pay and other Dodd-Frank reforms that apply to a broad swath of non-financial firms need to be justified on their own merits and not with an invocation of crisis spirits.
On the other hand, financial firms are fundamentally different beasts. We cannot stop with the standard analysis of agency costs that applies to the compensation arrangements at generic companies. The capacity of financial firms to externalize the costs of their risk-taking on the credit markets and the economy as a whole argues for additional scrutiny. The principal Federal bank regulators made this point in June 2010 guidance on compensation policies at banks. They wrote, “Aligning the interests of shareholders and employees, however, is not always sufficient to protect the safety and soundness of a banking organization.” The regulators argued that the presence of a federal safety net meant that shareholders may not care enough about whether a bank’s compensation policies encourage excessive risk. This argument could be taken a step further as the failure of firms, like Lehman, that did not receive a federal lifeline still caused massive economic damage. Financial firms need to be treated differently. Moreover, the agency cost rubric for looking at compensation that applies to most firms – does compensation align management and shareholder interests – may produce perverse results if applied to financial firms. Leo Strine of the Delaware Court of Chancery makes a case that further aligning manager interests with those of shareholders might further encourage short-termism – including high-reward-today-high-risk-tomorrow investments. This argument becomes stronger when applied to financial institutions.
If much of Dodd-Frank’s compensation focus is thus too broad, much of it is also too narrow. The compensation of non-executives – from traders at a Bear Stearns trading desk to mortgage brokers earning six figure incomes at Countrywide – may explain more of the perverse risk-taking in the crisis than the pay of ceos at those firms. Indeed, many of the most prominent ceos pilloried after the crisis – Cayne, Mozilo, Fuld – actually lost a significant chunk of their personal fortunes as their firms foundered. (See Fahlenbrach & Stulz for a more rigorous analysis).
If compensation – executive and non-executive -- at financial institutions is more directly connected to the crisis, then banking regulation offers a better toolbox for addressing skewed incentives for taking excessive risk produced by bad compensation arrangements.
