The Risks of Reward: The Role of Executive Compensation in Financial Crisis

Abstract

This Article examines the role of unbridled executive pay in exacerbating what Keynes called the animal spirits of the market. It analyzes the ways in which theoretical bases of executive pay structures diverge from reality, and the stakes for the firm and society in skyrocketing pay practices unlinked to performance. Various regulatory efforts, including the executive pay provisions of the Dodd-Frank Act, are intended to better align pay with performance. This article discusses these provisions and analyzes them in light of behavioral economics. Curbing executive pay is vital to controlling risk and preventing economic collapse, but the dynamics of group behavior make solutions to the problem complex. This article acknowledges the complexity of interconnected financial systems, and concludes that the solution lies in a combination of removing perverse incentives in the tax system, encouraging the use of deferred compensation, and legal reform, together with increased vigilance on the part of regulators regarding the interconnectedness of our economy