Yale Professor Robert Shiller writes in Sunday's New York Times that he and a group of professors have written a report that suggests it's time to change the way executives are paid if we want to prevent another financial meltdown. I am delighted to see that such distinguished academic leaders have finally reached the same conclusion nearly three years after I started writing about it.
Shiller and his colleagues assembled around New Hampshire's Squam Lake to conclude that since people respond to incentives, and executives are people, if our society withholds some of their pay, executives will take more care in their decisions to make sure that the companies they run don't go bankrupt.
Hold Executive Pay in Escrow for 10 Years
Back in 2007, I suggested that the way bankers are paid needs to change. Putting their compensation into an escrow account for 10 years would be a good start. If the securities their institutions create maintain their worth over the period, the bankers would be able to take their money out of the escrow account. If the securities became worthless, the escrow account would be used to pay off the investors who bought those securities.
This would make lenders think twice before they extend credit to people who can't pay back their loans. And why not? As I've noted many times, Gary Becker, a University of Chicago professor, won a Nobel Prize in 1992 for highlighting the ways that people respond to economic incentives. Schiller noted the same thing in introducing his proposal, without citing Becker.
Regardless of who came up with the idea, I think it should be a required part of financial reform. One thing is very clear to me: People don't go to Wall Street to make the world a better place for anyone but themselves. In other words, yes, they do it for the money.
Make Them Bear the Costs of Risk as Well as the Rewards
And only if their money is tied to both the rewards and the risks they take will their behavior change. The problem with the current financial reform package is that it continues to enable bankers to get paid up-front for closing deals while doing nothing to keep them from shifting the costs of their failed deals onto taxpayers. They don't bear the costs of the risks they take with what turns out to be our money.
And as long as bankers can keep doing that, they will continue to invent new ways to close ever bigger deals as fast as they can -- regardless of the risk.
I hope Shiller's support of the idea of holding banker pay in an escrow account will help make it happen. Until it does, we haven't seen the last financial crisis.
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