Bankers’ bonuses and the financial crisis

New research on banker pay

In recent research (Gregg et al. 2011), my colleagues and I investigate whether bank executives have been incentivised to take undue risks. To get this done, we examine the pay-performance relationship of executives in every UK companies, and in financial services companies specifically. We argue that, if an focus on short-term profits in the banking sector meant that remuneration structures in banks and financial services were to be blamed for the crisis, then there must be evidence that in the run-up to the crisis pay-performance sensitivities were higher in the financial services sector than in other sectors.

We report that base pay compensation and bonuses of most UK executives in FTSE350 companies increased substantially over the time 1994-2006, and that pay in the financial services sector is specially high. Pay of the best paid director (usually the CEO) increased by 131.78% and total board pay increased by 80.41% over the time 1997-2006, weighed against a 41.38% increase for all employees. Table 1 shows the way the average real pay of the best paid director and total board varies by industry, with the financial services sector ranking second under both measures behind the non-cyclical services sector, which include food and drug retailers and telecommunications.

Table 1 . Mean total board pay and pay of highest paid director by industry at 2006 prices

Highest paid director (£’000)

Yet, unlike the prediction that pay was over-sensitive to short-term performance, we find that the pay-performance sensitivity of banks isn’t significantly greater than in other sectors, and generally is really quite low. Across all industries, we look for a weak relationship between executive pay and company performance. The estimates claim that a 10% additional upsurge in company share price performance leads to a 0.68% upsurge in the pay of the CEO, which results in a £3,726 upsurge in CEO pay at the median degree of £543,200.

We report that although the pay-performance relationship is slightly higher in the financial services sector for both total board pay and pay of the best paid director, the excess sensitivity isn’t statistically significant, and continues to be economically really small. This tiny performance-related component of executive pay implies that there is little evidence that executive compensation in the banking sector depended on short-term financial performance. Put simply, executives were paid regardless of performance. In which particular case, it appears unlikely that bankers were incentivised to take chances, and refutes the suggestion that incentive structures in banks could possibly be blamed for the crisis 3 .

We also report that firm size includes a larger influence on executive pay than firm return. A 10% upsurge in firm size measured by total assets, increases CEO pay by 2%, which results in a £11,815 upsurge in CEO pay at the median level. Therefore, somewhat against the prevailing wisdom, that executive pay is more sensitive to firm size than firm performance.

It’s been argued that remuneration packages in the financial services sector might have been partly in charge of the global financial meltdown. It could appear, however, that the mechanism for this impact isn’t through the partnership between executive pay and currency markets performance, but instead through the incentive for executives to ensure their firm’s assets are as large as possible.

Concluding remarks

The reforms to executive remuneration in financial services through the adoption of a ‘Remuneration Code’ could be accused of jumping the gun, because it isn’t clear that bonus payments over-incentivised executives to begin with. However there are two explanations why such regulations work.

  • First, the necessity that bonus payments be fully transparent, partially deferred and performance-adjusted, make sure that executive bonuses are linked to long-term corporate performance, and seem reasonable conditions for just about any performance-related ‘variable compensation’ scheme.
  • Second, there were a number of corporate governance reports in the united kingdom over the last twenty years (Cadbury 1992, Greenbury 1995, Hampel 1998, Turnbull 1999, and Higgs 2003), yet these reports and recommended policies have didn’t stem the dramatic upsurge in executive pay.

In September 2011, the united kingdom government’s Department for Business, Innovation and Skills issued a discussion paper on structures for executive remuneration. If this latest report is to have any effect, it’s important that regulations stay one step prior to the regulated.


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Cadbury, A (1992), Report of the Committee on the Financial Areas of Corporate Governance, Gee & Co.
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Conyon, MJ, N Fernandes, MA Ferreira, P Matos, and KJ Murphy (2010), “The Executive Compensation Controversy: A Transatlantic Analysis”, redraft of Annual FRDB conference paper.
Department for Business Innovation and Skills (2011), Executive Remuneration: Discussion Paper, September.
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Fahlenbrach, R, and RM Stulz (2011), “Bank CEO Incentives and the Credit Crisis”, Journal of Financial Economics, 99, 11-26.
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Gregg, P, S Jewell, and I Tonks (2011), "Executive Pay and Performance: Did Bankers’ Bonuses Cause the Crisis?", International Overview of Finance DOI: 10.1111/j.1468-2443.2011.01136.x
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1 See also Walker 2009 and FSA 2009 for the united kingdom and US Senate 2011 for the united states.
2 Regarding executive remuneration, Walker (2009) and FSA (2009) identified potential market failures in the structures of remuneration practices in financial services, and suggested an focus on short-term profits by institutional investors had encouraged executive remuneration to be centered on “variable compensation” (bonuses) linked to the newest earnings, without the consideration of the contact with risk-taking.
3 Several other papers also have examined the evidence concerning whether mis-aligned incentives were the reason for the financial meltdown. Fahlenbrach and Stulz (2011) argue any perverse incentives are dampened if the interests of executives and shareholders are aligned through executives’ ownership of company stock.
In a comparison of the united states and Europe, Conyon et al. (2010) show that the role of compensation to advertise excessive risk taking before the crisis was dwarfed by the roles of loose monetary policy, social housing policies, and financial innovation. Beltratti and Stulz (2010) undertake a cross-country comparison of the performance of banks through the financial crisis, and discover that it had been the fragility of banks’ balance sheets, and specifically their reliance on short-term capital market funding, that explained their poor performance. However, Erkens, Hung and Matos (2009) examine corporate governance policies in 306 finance institutions across 31 countries through the credit crisis. As opposed to the evidence for all of us banks, they find that financial firms which used CEO compensation contracts with a heavier focus on non-equity incentives (bonuses) instead of equity-based compensation) performed worse through the crisis and took more risk prior to the crisis.

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