Professor Lucian Bebchuk testified yesterday before the Subcommittee on Financial Institutions and Consumer Protection of the United States Senate Committee on Banking, Housing and Urban Affairs. He participated in a hearing on “Pay for Performance: Incentive Compensation at Large Financial Institutions.” In addition to Bebchuk, the other witnesses testifying in the hearing were Kurt Hyde, Deputy Special Inspector General of the Troubled Asset Relief Program; Professor Robert J. Jackson, Jr., Associate Professor of Law at Columbia Law School; and Michael S. Melbinger, an executive compensation expert appearing on behalf of the Financial Services Roundtable.
In his testimony, Bebchuk explained how compensation practices at financial firms should be reformed to eliminate excessive risk-taking incentives. He described two distinct shortcomings of pay arrangements: first, excessive focus on short-term results; and, second, excessive focus on results for shareholders. He then discussed how pay arrangements should be designed to address each of these problems. In particular, Bebchuk explained how pay structures should be designed to induce executives to focus on long-term rather than short-term results, as well as to induce such executives to take into account the consequences of their decisions for all those contributing to the bank’s capital (rather than only for shareholders). Bebchuk suggested that the rules proposed by regulators last spring be strengthened to ensure that financial firms provide executives with such incentives. Because of the importance of providing such incentives for financial stability, he concluded, ensuring that financial firms provide such incentives should be regarded as a regulatory priority.
Bebchuk’s written testimony is available here.