IDEAS home Printed from https://ideas.repec.org/a/bla/jacrfn/v22y2010i3p65-72.html
   My bibliography  Save this article

Rethinking “Strength of Incentives” for Executives of Financial Institutions

Author

Listed:
  • John McCormack
  • Judy Weiker

Abstract

The recent crisis has caused some finance theorists and practitioners to rethink the effects of managerial incentives on the total enterprise value of large financial institutions. This re‐examination has identified and analyzed a number of potential problems with the use of equity‐based compensation, including insufficiently long managerial time horizons as well as the temptation for excessive risk‐taking provided by “asymmetric” payoff structures in which shareholders have virtually all the upside while debtholders bear most of the downside risk. In an attempt to address such problems, finance and governance scholars have increasingly explored the possible value of aligning managerial interests with those of not only shareholders, but other important corporate claimants such as debtholders and taxpayers. After reviewing the latest thinking about risk and managerial incentives at financial institutions, the authors come to the following conclusions: • The design of incentives for value maximization needs to reflect a healthy appreciation of downside risk as well as upside reward, and both senior and subordinated debt may be ideal instruments for establishing that balance. At the same time, most senior executives should continue to receive equity‐linked compensation in addition to significant proportions of “inside debt.” • Since decision‐makers below the highest level executives of large financial institutions collectively wield enormous power to assume and manage risks, this “upper‐middle” tier of managers deserves special attention. Rather than rewarding these managers with stock or options, the authors suggest use of a combination of uncapped but “held‐at‐risk” bonuses denominated in subordinated inside debt as the best way of rewarding effort and competence while controlling opportunities for risk‐shifting.

Suggested Citation

  • John McCormack & Judy Weiker, 2010. "Rethinking “Strength of Incentives” for Executives of Financial Institutions," Journal of Applied Corporate Finance, Morgan Stanley, vol. 22(3), pages 65-72, June.
  • Handle: RePEc:bla:jacrfn:v:22:y:2010:i:3:p:65-72
    DOI: 10.1111/j.1745-6622.2010.00291.x
    as

    Download full text from publisher

    File URL: https://doi.org/10.1111/j.1745-6622.2010.00291.x
    Download Restriction: no

    File URL: https://libkey.io/10.1111/j.1745-6622.2010.00291.x?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:bla:jacrfn:v:22:y:2010:i:3:p:65-72. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no bibliographic references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Wiley Content Delivery (email available below). General contact details of provider: http://www.blackwellpublishing.com/journal.asp?ref=1078-1196 .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.