Corporate & Securities Law

BEBCHUK AND STIGLITZ DON'T PULL PUNCHES ON CAPITOL HILL

On January 22, 2010, distinguished economists Lucian Bebchuck (Harvard Law School) and Joseph Stiglitz (Columbia Business School) testified before the House Committee on Financial Services regarding the impact of Wall Street executive compensation on the current financial crisis.  The testimony is summarized below.  (NOTE - The summaries are taken from the author's notes and have not been compared to verbatim transcripts)

• Lucian Bebchuk, Professor of Law, Economics and Finance and Director of the Program on Corporate Governance at the Harvard Law School

Professor Bebchuk testified that executive were rewarded for short-term results even when those results were subsequently reversed.  Predictably, such a compensation structure incented Wall Street executives to pursue short-term successes regardless of long-term consequences.  

At Bear Stearns, Executive Committee members cashed out large amounts of performance-based compensation during the 2000-2008 time period.  Professor Bebchuk estimated that the five top executives at Bear Stearns derived cash flows of about $1.4 billion from cash bonuses and equity sales from 2000 through 2008. None of this compensation was ?clawed back? when the firm collapsed.

• Joseph Stiglitz, University Professor of Economics, Columbia Business School

Professor Stiglitz testified that - despite high revenues for financial services companies during the housing boom / bubble - losses during the financial crisis already are greater than cumulative profits for the four years preceding the crisis.  In other words, short-term gains were illusory. From a long-term perspective, executive performance was negative.

Stiglitz also stressed the link between executive compensation incentives and bad management. He asserted that the prevailing Wall Street compensation structure encouraged reckless risk taking, excessive leverage, deceptive accounting, and financial models based on poor assumptions. 

Professor Stiglitz further explained that flawed incentives encouraged short-sighted behavior and led to creation and sales of low quality financial products.  He testified that Wall Street's executive compensation system led to poor risk management decisions and misallocation of investment capital. For example, Professor Stiglitz noted that the capital allocated to asset backed securities (i.e., mortgage-backed securities and CDOs) could instead have been invested in ways that would have improved long-term productivity of the overall U.S. economy.

By Brett Sherman, The Sherman Law Firm