Bernanke: Why Executive Compensation Matters

The Federal Reserve Chairman says compensation can drive unhealthy leadership incentives.

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Federal Reserve Chairman Ben Bernanke said today he wants bank compensation practices more closely monitored to prevent "mismatches between the rewards and risks borne by institutions or their managers." It's about more than quelling public and congressional anger, then.

From the AP:

Banking regulators have observed that "poorly designed compensation policies can create perverse incentives that can ultimately jeopardize the health of the banking organization," Bernanke told a meeting of smaller "community" banks in Phoenix, Ariz.

Why is it that banking supervisors need to be urged to monitor compensation practices, if the health of the organization is indeed at stake? Edward Lawler, a professor at USC and expert on compensation, had this to say about executive compensation when I interviewed him last year:

The problem with executive compensation is that there is no countervailing force. There is nothing really working to hold it down. The outrage that comes out annually as the proxies come out is about the only force that is acting potentially to push it down. There are no shareholder votes. Board members are often CEOs of other companies, and most of them are smart enough to realize that if their neighbor gets a raise, then that raises the overall compensation level for executives.

The other killer is: You don't want to be below market, do you? For your executive comp? You want below-market executives? Of course not. So we've got this never-ending upward spiral of compensation.

One common dilemma is: How do you measure performance? Not surprisingly, executives say: Well, that depends. If there's a downturn, did we go down less than the other guys? And if it's an upturn, maybe I didn't perform quite as well as the other guys, but look at the extra shareholder value that's been created.

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