The Effect of the Bonus Plan for Business Executives and CEOs on the Legalities of the Wall Street Financial Crisis

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The Effect of the Bonus Plan for Business Executives and CEOs on the Legalities of the Wall Street Financial Crisis

This paper addresses the question on how the bonus plan for CEO’s and business executives affect the legalities of the Wall Street financial crisis. Following the dreadful financial crises that ravaged the Wall Street, decisions on compensations in the financial industry became an issue of public concern since the global economy was experiencing a downward spiral. The unification of several factors such as overleverage balance sheets and lack of liquidity created a significant impact in the financial industry.  Hodak (2015) points out that when these mortgage-backed safeties/securities declined in value due to the fall of the housing fizz, the over-extended Wall Street organizations could not tolerate the loss in the increase in short-term liabilities and loss in asset worth/value. Apart from these effects, the compensation and bonus plans for chief executives negatively affects the legality of the Wall Street financial crisis in several ways, which are explored in this paper.

The bonuses/compensations awarded to the CEO’s and business executives leads to the collapse of the system of global finance. Since the pay of the executives is tied to the short-term gains, unwarranted risks were incurred in the form of CDSs (Credit Default Swaps) and CDOs Collateral Debt Obligations). Considering this argument, the executives’ packages are designed to motivate a get-rich quickly attitude and inspire an extremely risky behavior, which contributed significantly to the crashing down of the financial market and eradication of the profits of multiple firms. According to Kelly (2015), the bonus culture propels the financial system towards the wrong direction, as it encourages self-referential and discourages medium-term stability. Besides, it transforms the banking sector from a service sectors into a self-service sector.

Most of the compensation evaluations did not take into consideration the business executives who left organizations prior to the financial crisis. For instance, in the course of the 11 years prior to the crunch, three CEOs belong to Merrill Lynch were paid a figure exceeding $240 million in performance-based reward (Gilchrist, 2015). Furthermore, the U.S Treasury required that banks that had not settled the TARP (Trouble Asset Relief Programme) funds pay business executives almost wholly in stock. For instance, Citigroup’s executives could share $113 million in stock for the fiscal year 2009. However, in case the Citigroup’s stock dropped to the value just 2 months before, the shares of the executives would exceed $800 million (Kelly, 2015). Hodak (2015) asserts that this trend toward stock reward was not restricted to individuals holding the TARP cash due to the greater influence of the Pay Czar, who was in charge of re-establishing how workers were rewarded on Wall Street.

Overemphasis on stock also contributes to the complication of issues in the financial sector in relation to decreased lending activities. Shin (2015) argues that it was predicted that bankers could generate enormous gains on stock reward due to the depressed prices of stock at the time of their issue. For instance, in 2008, the aspect of compensation was considered low, but its value still increased when the entire system of finance began mending and stock prices of banks climbed (Shin, 2015). Many individuals were frustrated that the TARP funds’ investments could enable the financial institutions to engage in more lending operations. Financial organizations were more focused on trading their money, as opposed to lending money to individuals and companies. JP Morgan and Goldman Sachs were extremely profitable in taking large risks and proprietary trading, thereby making the weaker competitors unwilling or unable to shoulder.

CEOs and business executives’ bonus plan leads to uneven distribution of rewards across companies. This system creates a situation whereby most of the compensation generated from the financial sector goes to the hedge funds as opposed to investment bankers as well as currency and bond traders. Hodak (2015) argue that, in 2009, while the average compensation amounted to $1.5 million, this amount not distributed evenly among companies, an event that negatively impacted Wall Street’s reputation.

The structure of Wall Street firms undergoes a significant change following the adoption of the new bonus plans, particularly in relation to compensation. Traditionally, Wall Street employees and executives have been rewarded a mix of cash bonuses and stock as a revenue percentage. On the contrary, before the financial crunch, compensation had become cash-reliant/heavy in that bonus was not associated with the long-term organizational performance. As such, executives could walk away from firms at any time. According to Shin (2015), since the financial crunch, organizations began shifting their focus from compensations to stock, with the aim of preventing executives from the alternative of selling their shares. The culture of focusing on bonuses, as opposed to salary/wage was not novel to Wall Street, where a significant portion of traders’ and bankers’ salary was based on year-end performance compensations.

Until the 1970s, most of the Wall Street companies were private partnerships. As such, the capital of partners supported the companies’ activities, and bonus was considered a form of gain sharing (Gilchrist, 2015). Hodak (2015) state that profits from organizational operations were shared at the end of the year among the organizational partners as a revenue percentage. Therefore, the negation of compensation was done among partners and largely tracked the ownership amount within the firm as well as the partner’s ability to add worth/value to the company. When several financial organizations went public, with the inclusion of the firms at the core of financial crunch, the structure of compensation was not altered. Executives could still receive their salary in the same ways as they obtained while in partnerships. One of the legal issues associated with trend is that members of the public could lose a significant portion of their gains in case the traders of securities in these firms could lose their incomes and capital.

Limits established on the compensation level within the financial service industry have a higher likelihood of triggering undesirable and unintended consequences. Kelly (2015) points out that pay caps, which are impose on a subsection of companies could push their skilled traders, bankers, and other prospective professionals to unregulated companies. Besides, broader restrictions on the compensation of CEOs might even push components of this mobile industry to countries that are more receptive, leading to the drain of experience and talent.

In conclusion, considering the greater risk involved in the compensation plan for CEOs and business executives, adequate measures should be taken to terminate this system. This plan exposes members of the public to the risk of losing their profits in wall street firms. It can also lead to loss of talents and expertise to other nations and uneven distribution of gains among companies. These factors alongside the others mentioned in this paper bore a significant effect on the legalities of the Wall Street.