Thursday, June 2, 2011

Business Ethics and Leadership » Blog Archive » Incendiary incentives

Business Ethics and Leadership » Blog Archive » Incendiary incentives

Incendiary incentives

Author: admin

Why hasn’t anyone on Wall Street gone to prison for causing the financial crisis? In a recentSalon piece on the lack of criminal prosecutions in the wake of the disaster, Andrew Leonard argues that the root cause is decades of deregulation under both Republican and Democratic administrations.

Leonard writes:

The underlying problem here isn’t necessarily that CEOs are breaking the law, it’s that the financial sector has such a disproportionately large role in the U.S. economy. We need changes in incentive structures that penalize traders for taking on too much risk. Or new taxes on financial transactions that inhibit rank speculation. Or new regulations that simply reduce the profitability of banking and steer talent towards more productive enterprises.

If the incentive structures that encourage big risk taking stay in place, all the criminal prosecutions in the world aren’t going to do much good. And if we’re looking for a real crime, taking place right now, then we should focus on Washington, not Wall Street, where a weak attempt to re-regulate the banking industry — Dodd-Frank — is under continual, unremitting assault from Wall Street lobbyists and Republican legislators.

Sherron Watkins, the Enron vice-president who warned Ken Lay in 2001 that Enron could “implode in a wave of accounting scandals,” made a similar point in an article in theColorado Springs Gazette. Current reforms, she said, don’t do enough to prevent another financial disaster.

“Stock options incentivize risky behavior,” Watkins told the Gazette. “If you look at what happened at Lehman Brothers, they would have never taken the risks that they did if it had still been organized as a partnership. When they started playing with other people’s money, they swung for the fences…. Congress needs to repeal the 1993 law (on the deductibility of executive pay) and prohibit stock options for C-Class executives (CEOs, chief financial officers and other top executives) to remove the driver of the risky behavior.”

That law, aimed to narrow the gap between executives and workers, ended tax deductions on executive non-performance-related pay over $1 million, leading to a greater dependence on stock options for executive compensation. It hasn’t worked. According to the Chicago Sun-Times, “The median total 2010 compensation for CEOs of the Standard & Poor’s 500 was $9 million, a 25 percent increase from 2009.” The AFL-CIO says CEOs have gone from making 42 times the average worker’s salary in 1980 to 343 times the average worker’s salary in 2010.

In her interview with the Gazette, Watkins thought the whistle-blower protections passed by the SEC last month will encourage employees to notify the government and company executives of fraud. She also praised business school ethics programs for giving students the tools to deal with ethical challenges.

But if we want the extreme risk-taking to stop, we have to de-incentivize it.

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