Executive Bankers Compensation as Agency Problem
Executive compensation as an agency problem has been frequently discussed in media reports, with more frequent cases of CEOs quitting their jobs with large sums of money while leaving their companies in difficult financial situation (Kelly-Gagnon, 2011). The problem comes from the efforts which corporations and large financial institutions put into designing compensation packages in recognizing special roles of their CEOs. Typically, the problem is attempted to solve with bonuses and incentives as part of these compensation packages, which are calculated proportionally to increase of shareholder’s wealth. However, many recent cases have shown controversies in such compensation approach.
Two cases will be further reviewed in more detail relatively to this problem.The case of Lloyd BlankfeinOn April 2011, The Guardian’s columnist Andrew Clark reported a nearly double increase of Goldman Sachs CEO’s payment despite a 38% slump in bank’s profits (Clark, 2011). One year later, his compensation increased by 14,5% comparing to the previous year, resulting in $16,2 millions, while share prices and profits of the bank kept declining (Lacarpa, 2012). Blankfein’s compensation in 2011 included share awards and performance-related cash bonus over the salary, which was significantly lower ($600,000) comparing to the millions received in first two payment incentives. While these figures were lower than his highest awards received in 2007, capped at $68 millions, such increase in times of recession in declining market positions of Goldman Sachs created controversy in public, especially with Blankfeins’ claims on “exercising "restraint" in response to public and political pressure over the size of bonuses” (Clark, 2011, para. 4). A controversy of such sharp increases in executive pays, unsurprisingly, triggered significant attention from Wall Street, since thousands of traders, bankers and support staff were fired last year due to weak performance, not only in Goldman Sachs.
The bank explained the growth of Blanfein’s compensation with the fact that their performance was beter than the one of their competitors, leading to stronger positions on the market, which resulted into additional incentives to the investment bank’s CEO.In reality though, the case of Lloyd Blankfein’s compensation increases is typical agency problem which exists in banking industries. Agency theory specifies that shareholder value may be sacrificed by executives who lack the correct incentives, leading to less than optimal performance of the firm (Kelly-Gagnon, 2010). In case of Goldman Sachs, clients and other bank executives were sacrificed for creating tighter bonds between shareholders’ and CEO’s wealth through various activities heavily criticized in media. First, Goldman Sachs’ reputation is described as investing against the best interest of clients through creating mortgage-backed securities, also known as collateral debt obligations. These obligations have been sold shortly, betting them to undergo foreclosures. As a result of housing bubble in 2008, values of obligations dropped, allowing short-sellers like Goldman Sachs to make millions of dollars while leaving investors and property owners lost as a result of collapse. Such strategy, though, allowed the bank to resist a credit crunch in 2007, and further positively influenced the compensation offered for bank …
