Wednesday, January 2, 2013

Looking Back: An Overlooked Cause of the Financial Crisis (Off Topic)

At least a dozen factors contributed to the financial crisis.  Let's add one more -- a counterintuitive, overlooked factor -- and you heard it here first:  SEC compensation disclosure rules.

Among the most fervent readers of a public company's proxy statement compensation disclosures are executives at peer companies.   And few people have gone broke betting against the suppression of ego.

The SEC's 1992 overhaul of compensation disclosure rules, intended to curb executive compensation through comprehensive, meticulously detailed disclosures, instead had an opposite effect, creating favorable conditions for a compensation "arms race" that began in ensuing years.   (The law of unintended consequences strikes again.  And the Sarbanes-Oxley Act of 2002 did little to curb the then-developing compensation "arms race," as that act mostly concerned other, related topics.)   The SEC's 2006 revision of the rules, continuing its 1992 policy aims, intensified the race. The race was most intense and competitive at publicly-traded financial services firms and the largest public companies.

Seeking greater compensation to not fall behind actual peers and, too frequently, ostensible peers, senior executives at financial services firms -- few of which executives by their own estimation are average or below average performers -- increasingly caused or allowed their firms to take greater risks.  (Taking on greater risk is, on average, quicker, easier and more easily justified at financial services firms than at companies in other sectors.)  Also, over time, increasingly larger shares of the rewards of those risks benefited senior executive management at those firms, incentivizing even greater risk-taking.


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