A quantitative study by two finance professors of the executive compensation structure of the largest 14 U.S. financial institutions during 2000-2008 found that: (1) CEOs were incentivized to take excessive risks and were big net sellers of their own companies’ stock, and (2) that the poor performance of banks during this period was NOT the result of unforeseen risks, as claimed by some. See blog by Simon Johnson, “Ship of Knaves,” The New York Times, Feb. 10, 2011.
According to Johnson, the former chief economist at the International Monetary Fund, and co-author of “13 Bankers,” the key finding is that these CEOs were “30 times more likely to be involved in a sell trade compared with an open-market buy trade” of their own bank’s stock and “the dollar value of sales of stock by bank C.E.O.’s of their own bank’s stock is about 100 times the dollar value of open market buys.” ??If the chief executives had really believed in what their banks were doing, they would have wanted to hold this stock ? or even buy more, said Johnson, adding: “Disproportionately, more sales than purchases strongly suggests that the chief executives felt their stock was more likely overvalued than undervalued.”
But the key underlying problem, which incentivizes the taking of excessive risk, says Johnson, is the ability of CEOs to sell stock with very little restriction. “When the outcomes are good, as they may be for a while in an up market, the chief executive can turn his or her stock into cash. When the outcomes are bad, the chief executive doesn’t care so much because he or she already has cash ? and some form of government bailout or other support may be forthcoming.”
The bank CEOs made a great deal of money while long-term buy-and-hold shareholders lost money during the same period. The CEOs made more than $2.6 billion during 2000-8, while long-term shareholders in these 14 banks did very badly, particularly in 2008. This disparity was far more pronounced in big banks than small banks.
Johnson writes: “This points the authors toward moderate but appealing changes in executive compensation practices: ‘Executive incentive compensation should only consist of restricted stock and restricted stock options ? restricted in the sense that the executive cannot sell the shares or exercise the options for two to four years after their last day in office.”
But if you agree with this proposed change, prepare to be disappointed. Johnson explains: “The executives in question hire people like Steven Eckhaus, a top Wall Street compensation lawyer, who puts up a spirited defense of current practices and insisted to The Wall Street Journal just last weekend that “to blame Wall Street for the financial meltdown is absurd.'”
CEOs resist such changes and boards comply. The breakdown in corporate governance in the best interests of the shareholders is complete, writes Johnson.
Wall Street apologists argue that the financial crisis was unforeseeable and, at worst, the CEOs were “hapless fools.” But the numbers show otherwise. “The only fools here are the shareholders ? and the rest of society that buys into such a foolhardy scheme,” says Johnson.
Page Perry is an Atlanta-based law firm with over 125 years collective experience representing institutional and individual investors in investment-related litigation and arbitration all over the country. While past results are not indicative of future success, Page Perry’s attorneys have recovered over $1,000,000 for clients on more than 40 occasions.