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In Managerial Economics - Essay Example

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Running head: Design and Justify an Optimal Compensation Scheme to Reward Bank CEOs Name: Institution: Date: Introduction There has been an intense debate over the high level of payment to the CEO. Compensation of the executive is often a continuous and complex subject that involves the nature and process of the pay setting as well as the results such a setting generates…
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Essay in Managerial Economics
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In Managerial Economics

Download file to see previous pages... In the banking industry therefore, these relationship in governance may be quite complicated in the sense that the regulatory oversight is very likely to compromise the alignment of incentives. Several arguments have been advanced to suggest that the huge payment packages to the executive emanate from the influence of powerful managers who design the payments as well as extracting rents from companies. On the other hand, some argue that the large pay package for the executives is a result of optimal contracting in a market that is fairly competitive especially for talents in management. The importance of regulators as Berger et al. (2000) argue is to evaluate the bank holding condition. The supervisor analyze firm on the basis of financial conditions and risk management as well as present a bank with an assessment that is confidential. The issue of supervisory rating is related to executive compensation in banks, in that weaker ratings are closely related to intensive outside monitoring by the regulators. As such, the most favorable executive compensation design can be developed from a trade-off between risk shifting and perk consumption both of which are agency problems that the executives are faced with. Risk shifting can be said to be the risky behavior that managers undertake because of an incentive based compensation or reward. Perk compensation on the other hand, is consuming perks to the detriment of shareholders especially when there is little or no incentive based compensation for the managers. In instances where there is strong outside monitoring by the regulators, the limit risk usually shift on the managers part paid equity, consequently, an optimal design of executive compensation is achieved with improved sensitivity of pay for performance. Consequently, regulatory monitoring is capable of increasing the risk adverse behavior on the part of the executive. It therefore follows that in order for the executive to perform, their payment must be related to their performance. The banking industry is a unique sector in the sense that it must be able to operate within the regulatory confines (Sierra et al. 2006). The importance of government regulation cannot there be overemphasized. This is because the deposit insurance as well as system of payment ensures that the government can effective make a claimant on the assets of a bank. Discussion In the current global financial crisis, there are several causes that have been on the spotlight to explain the state. This causes as advanced include: the guiding philosophy for the global neo liberalism, the increase in the number of the subprime mortgages, and also the presence of the real estate market that is uncontrolled. That notwithstanding, it is the contention of this paper that there is more to current status than the aforementioned causes and that the main contributor to the current crisis has its roots in the problem of incentive. According to Fee & Hadlock (2003), an incentive can be defined in simple terms as a way of convincing persons to do less of the bad things and more of the good ones. It goes without saying that incentives form the basis of corporate life, especially in instance where the executives are involved, understanding them can be a key factor in addressing almost any riddle in an organization. However, the current corporate governance ...Download file to see next pagesRead More
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