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By Ronald Fink
The senior-most executives of two investment banks whose failures were at the center of the financial crisis lost no money themselves, a new study shows. Instead, the executives profited handsomely while shareholders were saddled with huge losses.
The top five executives at Bear Stearns and Lehman pocketed about $1.4 billion and $1 billion, respectively, from 2000 to 2008, according to the study. That works out to roughly $250 million per executive.
In contrast, shareholders in Bear received pennies on the dollar in March 2008, when the Federal Reserve backstopped its acquisition by JP Morgan Chase. Shareholders in Lehman were completely wiped out when that firm went bankrupt six months later.
The findings led the study's authors, Lucian Bebchuck, a law professor at Harvard University who heads its program on corporate governance, and Alma Cohen and Holger Spamann, two researchers affiliated with the program, to conclude that restraining compensation on Wall Street is critical to reforming the financial system, and that calls for such restraint should not be dismissed as "populist" rage.
The authors reported their findings, which contradict some press reports in the wake of the banks' failures, in a column published on Thursday by Project Syndicate.
Bebchuk and his colleagues found that the two banks' top executives regularly unloaded shares and options, and thus were able to cash out a considerable portion of their equity before the stock prices of their firms plummeted.
In fact, the study, entitled "The Wages of Failure: Executive Compensation at Bear Stearns and Lehman Brothers 2000-2008,"shows that the top five executives unloaded more shares during the years prior to their firms' meltdown than they held when the banks collapsed in 2008. Altogether, from 2000 to 2008, the top executive teams at Bear Stearns and Lehman cashed out about $1.1 billion and $850 million (in 2009 dollars), respectively.
The payoffs were further increased by large bonus compensation. From 2000 to 2007, the study found, the top executives' aggregate bonus compensation reached (in 2009 dollars) $300 million at Bear Stearns and $150 million at Lehman.
The earnings that provided the basis for these bonuses evaporated in 2008. But the study also found that the firms' pay arrangements did not contain any "claw-back" provisions that would have enabled the firms to recoup the bonuses that had already been paid.
"After Bear Stearns and Lehman Brothers melted down, ushering in a worldwide crisis, media reports largely assumed that the wealth of these firms' executives was wiped out, together with that of the firms they navigated into disaster," Bebchuk, Cohen and Spamann wrote. "This 'standard narrative' led commentators to downplay the role of flawed compensation arrangements and the importance of reforming the structures of executive pay."
Instead, the authors said, "such reform could do a great deal to improve incentives and prevent the type of excessive risk-taking that firms encouraged in the years preceding the financial crisis." For that reason, they added, "calls for comprehensive and robust reform of pay structures should not be viewed as mere responses to populist anger."
The Federal Reserve Board has said it will take compensation into account when reviewing banks' risk management practices but has refrained from issuing specific rules regarding it.
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