Bank Executive Pay
In the wake of the financial crisis and the unprecedented government intervention that followed, the compensation of bank executives has been heavily criticized. Some claim that it encouraged financial institutions to take excessive risks and had a hand in precipitating the crisis. To gain some understanding on the issue, we examine trends in executive compensation in the banking and finance industry over the past couple of decades. We look at whether bank executives received higher pay than executives in other industries and whether compensation patterns have implications for banks’ risk-taking behavior.
Compensation rose steadily for executives in all industries from 1992 to 2000. Banking and finance executives were the best compensated executives of any industry over the period, and they reached their highest levels of pay in 2000, with the average compensation totaling nearly $4 million. They were followed closely by executives in the service, transportation, and utility industries.
Total compensation declined significantly after the dot-com bubble burst in 2000. Banking and finance executives saw their pay fall around that time for two years straight (2001-2002) and then stay flat for another two (2003-2004). Then, as the credit boom took hold before the financial crisis, the pay of banking and finance executives picked up again in 2005, and it reached its second-highest level in 2006. Thereafter, however, total compensation for bank executives declined more than 20 percent, falling from $3.5 million in 2006 to $2.8 million in 2008. It is expected to continue to decline as the federal government unfolds its plan for regulating compensation at financial institutions. As a result of the downward trend, banking and finance lost its position as the highest executive-paying industry in 2007 to transportation and utilities, and mining and manufacturing caught up with it in 2008.
The banking and finance industry can be divided into five groups: commercial banks, nondepository credit institutions (lenders), securities and commodities brokers and dealers, insurance, and real estate. Overall, nondepository lenders and brokers and dealers pay their executives most and account for most of the volatility in compensation across the entire industry. Following a trend that is similar to the industry as a whole over time, executives working for nondepository lenders and brokers and dealers received $2.1-2.4 million in 1992, which had more than doubled to $4.7-5.0 million by 2008 despite obvious drops in total compensation figures among brokers and dealers since 2006 and among nondepository lenders since 2007.
Executive pay at commercial banks, insurance firms, and real estate companies trailed far behind the industry leaders. The trend at commercial banks is almost identical to the industry as a whole, though with ups and downs of smaller scales, and their executive pay in 2008 was the lowest among all groups, with an average of $1.8 million.
Insurance companies have increased their executive pay steadily since 1992, regardless of economic conditions, reaching an average of $3.4 in 2008. Executive pay at real estate companies spiked in 1996, then declined sharply through 1998, and increased continuously from 2002 to 2006, all of which seems related to movements in the housing market. In 2008, real estate companies offered an average of $2.1 million to their executives, slightly more than commercial banks.
There are four main types of compensation: salary, bonuses, restricted stocks, and stock options. Though it is the base for all other types of compensation, salary comprises only a small portion of total compensation. For most of the years we’ve been looking at, salaries trailed bonuses (until 2006), restricted stocks (since 2003), and stock options (since 1994). Moreover, salaries increased steadily but slowly from $311,000 in 1992 to $468,000 in 2008, which was equivalent to an annual raise of 2.6 percent.
In the meantime, bonuses, which are typically tied to short-term financial performance, increased from 100 percent of salary in 1992 to 216 percent in 2005, then dropped by half to 118 percent in 2006 and more than another half to 41 percent in 2008. The boost in bonus payments up to 2005 might have encouraged bank executives and employees to take actions that favored short-term profitability at the expense of long-term financial health, and the subsequent drop could be a response to the general public’s criticism as well as a reflection of declining profits (which could be the result of earlier activities of “short-termism”).
Stock and stock option grants are usually considered to be a means of providing managerial incentive for developing long-term growth and profitability. When given the firm’s equity or the option to acquire equity at a price that is below the market price, managers are likely to act more like shareholders. Holding too many shares or options can induce managers to take on higher risk, though. We see that the value of restricted stock grants has increased significantly over time, especially since 2003, whereas stock options dominated during the period of 1997 to 2002 (possibly due to the favorable accounting treatment for granting employee stock options at that time), then faded to some degree and stayed fairly constant at $600,000-700,000 in later years.
Now let’s look at how three specific types of compensation—bonuses, restricted stocks, and stock options â€“ varied across the five groups in banking and finance over time. These trends may provide us with some ideas about who was more likely to engage in activities of short-termism or take on excessive risk and at what time.
First, commercial banks, insurance firms, and real estate companies stayed quite close to one another in terms of the level of bonuses paid from 1992 to 2005. All of these sectors witnessed a persistent, gradual rise in bonuses over the period, yet a sharp decline afterward. Securities and commodities brokers and dealers paid the highest bonuses, but the figures changed considerably from year to year. Nondepository lenders offered the second-highest bonuses, and in a few years (1995, 1996, and 2008), their bonuses actually equaled those of brokers and dealers.
Second, commercial banks, insurance firms, and real estate companies, again, stayed quite close together in terms of restricted stock grants, whereas there were more variations in stock offerings at brokers and dealers as well as nondepository lenders. One noticeable change over time is that restricted stock grants at commercial banks have more than doubled since 2005. Stocks with an average market value of $850,000 to $1 million per executive were offered in 2008 among all banking and finance groups except insurance companies.
Third, all of the banking and finance groups except real estate companies increased the amount of stock options granted to executives between 1996 and 2000, but have, in general, decreased them thereafter. Between 1997 and 2005, nondepository lenders offered the highest value of stock options, followed by brokers and dealers, insurance companies, commercial banks, and real estate companies. The option value offered by real estate companies reached its peak in 1996. Finally, the differences between these groups in stock options granted have been getting smaller since 2006.