Executive Compensation

Topics: Subprime mortgage crisis, Executive compensation, Lehman Brothers Pages: 5 (1948 words) Published: February 18, 2013
1. Introduction
Executive Compensation is a composite phenomenon. It is an aspect of executive hiring that includes salary, cash, bonuses, stock option, pension contributes and other components that create the earnings of a top executive (Finkelstein & Hambrick, 1989). This paper focuses on providing an analysis of arguments in a debate whether the executive compensations the main performance drive and the reason for the financial crisis 2007-2009 because over the past three decades, the level of the executive compensations raised excessively. (Frydman & Jenter, 2010). “From the mid‐1970s, compensation levels grow dramatically, differences in pay across managers and firms widen, and equity incentives tie managers’ wealth closer to firm performance” (Frydman & Jenter, 2010). Especially after the financial crisis of 2007-2009 many had the opinion that this type of payment to the executives “might have encouraged excessive risk-taking” (Bebchuk, Cohen, & Spamann, 2010). Firstly, this paper will demonstrate how executive compensations at Lehman Brothers lead to the bankruptcy of the bank during the financial crisis. Secondly, this paper will explore how Apple uses executive compensation to insure that executives focus on long term profitability of the company. Finally, there is an explanation how the two examples fit in into the empirical research cycle. 2. Executive compensation at Lehman Brothers

A well-known example where executive compensation came under scrutiny from the broad public and authorities is the failure of Lehman Brothers during the financial crisis of 2008. The compensation showed increased over the consecutive years as deregulation in the United States enabled banks to take more risk. Following 9/11 the interest rate from the Federal Reserve Bank (FED) had decreased to only 1%, which also made banks more eager to loan money to people who beforehand were unable to do so. 3

Banks were allotted more freedom by the FED under the leadership of Alan Greenspan, a firm believer in the self-regulation of free markets. In 2005, Greenspan went on the record claiming that the private sector had done a better job than regulation would have ever done. He withdrew this opinion after the crisis in 2008 and called upon his successor Ben Bernanke to regulate the market (Lanman & Matthews, 2008). This firm believes of Greenspan turned out to be incorrect and the US government eventually had to intervene as banks had been taking too great risks. Even credit rating agencies such as Moody’s and S&P rated these types of mortgages as AAA, meaning the safest possible investment (Van Voris & Hurtado, 2012). Lehman Brothers went bankrupt during the financial crisis in September 2008, after many sub-prime mortgages became worthless, because people couldn’t afford them. They would never pay back what was loaned to them, leading to foreclosures. Between 2003 and 2008 the bank awarded over $700 million in executive compensation to its top 50 executives (Hamilton, Tangel & Pfeifer, 2012). This ever increasing compensation caused executives to focus on short-term goals rather than the long-term goals that were in the interest of the company. The vicious circle that Lehman Brothers kept paying higher compensation was the desire to achieve higher profits in the short-run. The higher compensation would make the executives more motivated and would also keep talent within the company. The belief within the bank was that these high pay-outs would enable the bank to make more profit. The bank’s desire to keep talent would take compensation to levels to unprecedented level, with the highest individual compensation being over $50 million in 2007. The question is whether this vicious circle is within the interest of the company. In hindsight, it can be said that the ever rising compensation would only interest executives in profit in the short run, and not as to in what shape they would leave the company behind. The ever higher compensation would...
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