Executive Pay and the Credit Crisis of 2008 - Case Study Example

Executive Pay and the Credit Crisis of 2008 Executive Pay and the Credit Crisis of 2008 The need for identifying the cause of the 2008 credit crisis has caused many debates especially in the aftermath of the crisis. The alleged causes range from the deregulation of banking institutions to structured finance and credit rating. These debates notably focus exclusively on the compensation packages of executive and greedy bankers. Nonetheless there are several questions which emanate from the fact that many banks whose top executives are alleged to have been paid for their level of performance collapsed.

It is evident that the link between risk taking and executive pay is questionable. It is therefore apparent that the level of executive compensation alone is not the real or actual cause of the credit crisis of 2008. Leading economists argue that it is hard to ascribe how performance pay structure would motivate excessive taking of risk within all levels of a company including underwriters, traders and CEOs (Moore & Baker, 2010). On the other hand, it has been found out that the executives who were involved in excessive risk taking prior to the crisis contributed more to its occurrence (Sepe, 2011).

In the light of these reflections, it is apparent that a combination of factors led to the credit crisis of 2008 as described in the following sections. The important question to ask is “why did the crisis affect certain financial institutions more than other?” as postulated by Narayanan, Ferri & Brem (2010). This question helps in understanding that there are many other significant causes of the credit crisis of 2008. It is argued that too accumulation of total debt per aver unit of GDP and person from 1980 to 2007 played a significant role in the credit crisis (Bebchuk, Cohen & Spamann, 2010).

Moreover the looming Social Security and Medicare structural deficits made the US increasingly insolvent because of the off-balance sheet debt which emanated from these deficits (Graafland & Ven, 2011). Nonetheless, the deregulation of the US financial sector played the most significant role in the crisis due to the fact that the financial sector is a giant source of tax to the US government. The mortgage regulation was specifically poor because of its characteristic low rates of interest. This led to the real estate bubble and mortgage boom.

Furthermore the early signs of financial fragility especially between 2007 and 2008 are accredited to the credit crisis of 2008 (Bebchuk, Cohen & Spamann, 2010). The financial crisis of 2008 would have been prevented through proper regulation by the government. The regulation of the financial institutions would have specifically been focused at ensuring that the mortgage market was controlled to ensure that pliable interest rates were implemented. Moreover, the priorities of the government expenditure would have been reevaluated to ensure that credit crises would not occur.

More significantly, proper design and implementation of policies by banking institutions would have prevented the crisis (Moore & Baker, 2010). For example the policies on issuance of credit and the associated interest would have been stricter. Furthermore the policies of banking institutions should have been designed to discourage over indulgence in credit risk by its executives. In this sense the issue of executive pay and its relation to the credit crisis would not have emanated. It is important however to note that executive pay played a role towards the crisis.

Nonetheless, executive pay by itself did not lead to the crisis. This is because executive pay in conjunction with the aforementioned factors contributed to the credit crisis of 2008. In this regard, the crisis would have been prevented through proper regulation of executive pay through the legal system and the policies of financial institutions (Bebchuk, Cohen & Spamann, 2010). The government and regulators have played important roles in the regulation of executive pay. Nonetheless, it is important to consider whether the regulation of executive pay is the most effective way of preventing future crises or not.

Through the Department of the Treasury, the US government has limited executive compensation. The government “limits bonus payments” within the financial institutions (Narayanan, Ferri & Brem, 2010). This is an appropriate way of protecting the investments of the taxpayers. Moreover, the effectiveness of regulators is demonstrated by the fact that bonus are regulated with an aim of ensuring that inaccurate criteria of giving bonuses are not used by companies. However it is recommended that the government should not directly regulate executive compensation within financial institutions.

Instead, the government as a stakeholder in financial markets should delegate decisions on executive compensation to third parties. This would include firms which act as advisors to shareholders and boards of financial institutions on matters of executive compensation. It is important to consider that this recommendation is not an opposition to the proposals for improved corporate governance. Top economists argue that even though regulations are designed to make companies more productive, the possible negative consequences of such regulations must be considered (Obi, Jeong-Gil & Sil, 20141).

More importantly is the fact that executive incentives would act to promote the long term interests and benefits of the shareholders. References Bebchuk, L. A., Cohen, A., & Spamann, H. (2010). The wages of failure: Executive compensation at bear Stearns and Lehman 2000-2008. Yale Journal on Regulation, 27(2), 257-282 Graafland, J., & Ven, B. (2011). The Credit Crisis and the Moral Responsibility of Professionals in Finance. Journal of Business Ethics, 103(4), 605-619. Moore, W. B., & Baker, C. A. (2010).

The 2008 financial crisis: FAS 157 and SAS 59 - did they reflect reality?. Journal of Finance & Accountancy, 41-9. Narayanan, V. G, Ferri, F. & Brem, L. (2010). Executive pay and the Credit Crisis of 2008. Harvard Business School. 2-18 Obi, P., Jeong-Gil, C., & Sil, S. (2011). A Look Back at the 2008 Financial Crisis: The Disconnect between Credit and Market Risks. Finance A Uver: Czech Journal Of Economics & Finance, 61(1), 400-413. Sepe, S. M. (2011). Making sense of executive compensation.

Delaware Journal of Corporate Law, 36(1), 189-235