Investment Bankers’ Culture of Ownership?

49 Pages Posted: 25 Aug 2010

See all articles by Sanjai Bhagat

Sanjai Bhagat

University of Colorado at Boulder - Department of Finance

Brian J. Bolton

University of Louisiana at Lafayette

Date Written: August 24, 2010

Abstract

We study the executive compensation structure in the largest 14 U.S. financial institutions during 2000-2008. Our results are mostly consistent with and supportive of the findings of Bebchuk, Cohen and Spamann (2010), that is, managerial incentives matter - incentives generated by executive compensation programs led to excessive risk-taking by banks leading to the current financial crisis. Also, our results are generally not supportive of the conclusions of Fahlenbrach and Stulz (2009) that the poor performance of banks during the crisis was the result of unforeseen risk.

We recommend the following compensation structure for senior bank executives: 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. However, managers should be permitted to annually liquidate about 5% to 15% of their ownership positions, but these annual ownership position liquidations should be restricted to an amount of $5 million to $10 million. This compensation structure will provide managers stronger incentives to work in the interests of long-term shareholders, and avoid excessive risk-taking.

While our focus here is on banks, corporate board compensation committees of firms in other industries should also give the above executive incentive compensation structure serious consideration. Additionally, we suggest that directors should adopt a similar incentive compensation structure with regard to their own incentive compensation.

Suggested Citation

Bhagat, Sanjai and Bolton, Brian J., Investment Bankers’ Culture of Ownership? (August 24, 2010). Available at SSRN: https://ssrn.com/abstract=1664520 or http://dx.doi.org/10.2139/ssrn.1664520

Sanjai Bhagat (Contact Author)

University of Colorado at Boulder - Department of Finance ( email )

Campus Box 419
Boulder, CO 80309
United States
303-492-7821 (Phone)

Brian J. Bolton

University of Louisiana at Lafayette ( email )

Lafayette, LA 70504
United States

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