Pay Now, Lose Later: The Role of Bonuses and Non-Equity Incentives in the Financial Meltdown of 2007-2009

This paper draws attention to and raises questions about an area of executive incentive compensation, bonuses and non-equity incentives, which seems to have disproportionally rewarded executives while shareholders remain exposed to substantial ongoing economic risks. This area of focus has surfaced because, beginning in 2007 and continuing throughout 2008, financial services firms incurred massive losses, while in the years immediately preceding this deluge of losses many executives were awarded substantial bonuses and non-equity incentives. We assess the risks associated with such payments and build a framework for assessing how shareholder and executive interests diverge as a result of bonuses and non-equity compensation. Our analysis is also meant to serve as a building block for future empirical studies about the relationship between executive incentive compensation paid in cash (bonuses and non-equity incentives) and the financial misstatements and overstatements of income that were at the heart of the financial meltdown.