(Press-News.org) CHAMPAIGN, Ill. — Reforms aimed at curbing executive compensation will likely have little effect on reducing systemic risk in the financial system, and they may even have unintended consequences for the freedom to contract, according to a University of Illinois expert in business law and corporate finance.
In a paper published in the Ohio State Entrepreneurial Business Law Journal, law professor Christine Hurt argues that giving regulators unprecedented power to prohibit certain types of private compensation under the guise of minimizing systemic risk in the financial system is an unwise move that could ultimately undermine the freedom of contracts.
"Since the financial crisis, both states and the federal government have tried to go in and rewrite existing contracts or put limits on what people can contract for in various areas," said Hurt, a co-director of the Program in Business Law and Policy at Illinois. "We do all sorts of things because we are confident in contracts as enforceable legal documents. Why? Because we believe in contract law, and that courts will uphold contracts. But if it gets to the point where courts can go in and change contracts – well, contracts won't be worth the proverbial paper they're printed on. Ultimately, that could have an impact on everyone whose contractual compensation suddenly seems undeserving, from the executive level to public employees and retirees."
Whether it's executive compensation or public union contracts, just because one side of the contract is disadvantageous to one party doesn't mean courts or legislators should be able to rewrite it, Hurt says.
"Generally, legislators have had little appetite for interference with private contracting," she said. "But in the wake of the housing crisis, it now seems that various government actors do have some interest, provided the benefits of the new contract favor a sympathetic party. Executive compensation reform would be a good example of an easy target of such contract reform, since people love to turn their scorn to the highly paid."
Although executive compensation has become a lightning rod for legislation, it's actually, in the grand scheme of things, "a very small amount of dollars," Hurt said.
"In the aftermath of the financial crisis, we think that all of these financial firms took on way too much risk and that their actions threatened our economy. But instead of trying to figure out what went wrong, and what prompted them to take on so much risk, legislators have naturally gravitated to executive compensation, which the general public has always thought was way too high. So now we have this new argument for capping executive compensation."
According to Hurt's paper, no theoretical or empirical link exists between how much executives are paid and how much systemic risk their firms cause.
"If you think of AIG and Lehman Brothers, and all the really bad positions they had in mortgage-backed securities, the people who made those trades weren't executives," said Hurt, the Guy Raymond Jones Faculty Scholar at Illinois. "The people who approved those trades weren't executives. So if there is behavior that leads to systemic risk, it's firm-wide by employees – employees who executive compensation reforms are never going to touch.
According to Hurt, if a financial behemoth such as Lehman Brothers was unable to foresee that its compensation program was going to lead to devastating loss, then it's hard to believe that regulators would be able to have better predictive powers than those with the incentive to stop it.
"A decade or two ago, there was a push for incentive-based compensation because we thought if executive pay was tied to a firm's performance, that would ensure we're paying for performance," she said. "So instead of just paying an executive $10 million, we paid them $1 million plus stock options. And that has led to all sorts of creative chaos. Not only are executives allowed to hedge away the downside risks of their stock options, but it also incentivizes them to take risks so the stock price goes up."
Hurt says it's hard to see how Congress comes up with a better solution.
"The last time that we had this debate, the legislature comes up with pay-for-performance," she said. "Well, pay-for-performance may have caused the financial crisis. Critics have been pointing to a lot these firms that we blame for causing the financial crisis – Fannie Mae, Freddie Mac, AIG, Lehman Brothers, Goldman Sachs – and saying, 'See, all of their executive are very well-compensated. Therefore, it must be the money that led these firms into ruin.' Well, these were very large firms, and if they weren't large firms they wouldn't have had an impact on the economy.
"Generally speaking, people at large firms make a lot of money. But there's no logic to saying if they had made a little bit less money, then the financial crisis could have been avoided."
INFORMATION:
Editor's note: To contact Christine Hurt, call 217-244-8293; email achurt@illinois.edu.
The paper, "Regulating Compensation," is available online.
Executive pay reform unlikely to reduce systemic risk in economy
2011-07-22
[Attachments] See images for this press release:
ELSE PRESS RELEASES FROM THIS DATE:
Study: Regulatory hurdles hinder biofuels market
2011-07-22
CHAMPAIGN, Ill. — Regulatory hurdles abound for the successful commercialization of emerging liquid biofuels, which hold the promise of enhancing U.S. energy security, reducing greenhouse gas emissions and serving as a driver for rural economic development, according to new U. of I. research.
In the study, University of Illinois law professor Jay P. Kesan and Timothy A. Slating, a regulatory associate with the University of Illinois Energy Biosciences Institute, argue that regulatory innovations are needed to keep pace with technological innovations in the biofuels industry.
"Getting ...
Chance favors the concentration of wealth, U of M study shows
2011-07-22
Most of our society's wealth is invested in businesses or other ventures that may or may not pan out. Thus, chance plays a role in where the wealth of a society will end up.
But does chance favor the concentration of wealth in the hands of a few, or does it tend to level the playing field? Three University of Minnesota researchers have built a simplified model that isolates the effects of chance and found that it consistently pushes wealth into the hands of a few, ever-richer people.
The study, "Entrepreneurs, chance, and the deterministic concentration of wealth," ...
NASA sees Tropical Storms Bret and now Cindy frolic in North Atlantic
2011-07-22
Two tropical storms are now in the open waters of the North Atlantic: Bret and Cindy. Both were captured on one image from NASA today. Both storms are hundreds of miles to the east-northeast of Bermuda and pose no threat to land areas.
NASA's GOES Project issued an infrared image of both Bret and Cindy today from the GOES-13 satellite, which is operated by NOAA. The NASA GOES Project is housed at NASA's Goddard Space Flight Center in Greenbelt, Md. and uses GOES-13 data from NOAA to create images and animations. The image was captured at 0845 UTC (4:45 a.m. EDT) and shows ...
MIT: Inside the innards of a nuclear reactor
2011-07-22
CAMBRIDGE, Mass. -- As workers continue to grapple with the damaged Fukushima Daiichi nuclear powerplant in Japan, the crisis has shone a spotlight on nuclear reactors around the world. In June, The Associated Press released results from a yearlong investigation, revealing evidence of "unrelenting wear" in many of the oldest-running facilities in the United States.
That study found that three-quarters of the country's nuclear reactor sites have leaked radioactive tritium from buried piping that transports water to cool reactor vessels, often contaminating groundwater. ...
Is anesthesia dangerous?
2011-07-22
In pure numerical terms, anesthesia-associated mortality has risen again. The reasons for this are the disproportionate increase in the numbers of older and multimorbid patients and surgical procedures that would have been unthinkable in the past. This is the result of a selective literature review of André Gottschalk's working group at the Bochum University Hospital in the current issue of Deutsches Ärzteblatt International (Dtsch Arztebl Int 2011; 108[27]: 469-74).
In the 1940s, anesthesia-related mortality was 6.4/10,000. By introducing safety standards such as pulse ...
Grazing management effects on stream pollutants
2011-07-22
MADISON, WI, JULY 21, 2011 -- Surface water quality is important for the proper function of aquatic ecosystems, as well as human needs and recreation. Pasturelands have been found to be major sources of sediment, phosphorus and pathogens in Midwest surface water resources. While poor grazing management may lead to contaminated surface water, little is known about the specific amount of pollution in pasture streams that can be attributed to grazing cattle.
Scientists in the Departments of Animal Science, Veterinary Diagnostic and Production Animal Medicine, and Veterinary ...
Elimination of national kidney allocation policy improves minority access to transplants
2011-07-22
A new study published in the American Journal of Transplantation reveals that since the elimination of the kidney allocation priority for matching for HLA-B on May 7, 2003, access to kidney transplantation for minorities has been improved. Improvement is a result of a policy that reduced the requirements for tissue matching.
Prior national kidney allocation rules provided priority to candidates who shared HLA-B antigens with potential deceased donors. On May 7, 2003, allocation priority for HLA-B matching was eliminated. Improvements in medications used to prevent transplant ...
Researchers stumble on colorful discovery
2011-07-22
Modified metals that change colour in the presence of particular gases could warn consumers if packaged food has been exposed to air or if there's a carbon monoxide leak at home. This finding could potentially influence the production of both industrial and commercial air quality sensors.
"We initially found out by accident that modified rhodium reacts in a colourful way to different gases," says Cathleen Crudden, a professor in the Department of Chemistry. "That happy accident has become a driving force in our work with rhodium."
Rhodium that is modified using carbon, ...
UCI-led butterfly study sheds light on convergent evolution
2011-07-22
Irvine, Calif., July 21, 2011 – For 150 years scientists have been trying to explain convergent evolution. One of the best-known examples of this is how poisonous butterflies from different species evolve to mimic each other's color patterns – in effect joining forces to warn predators, "Don't eat us," while spreading the cost of this lesson.
Now an international team of researchers led by Robert Reed, UC Irvine assistant professor of ecology & evolutionary biology, has solved part of the mystery by identifying a single gene called optix responsible for red wing color ...
Minority participants crucial to effective aging studies
2011-07-22
A new supplemental issue of The Gerontologist urges aging researchers to include representative samples of ethnically diverse populations in their work. The publication also identifies research priorities for moving the science of recruitment and retention forward, in addition to providing several strategies that scholars can employ in their work. The U.S. Census Bureau predicts that non-white minorities will make up 42 percent of the country's 65-and-over population by 2050.
"The cultural-historical background and sociopolitical conditions of each diverse group poses ...