Factor Essay

2014 words - 9 pages

Credit crisis can be simply defined as a situation where there is a lack of funds available in the credit market due to default on loans of the borrower to the financial institution. This situation happened as more borrowers default on their loans and the financial institutions simultaneously will stop receiving a large amount of payments. Then, the financial institutions will reduce the lending or increases the cost of borrowing to a higher rate to recover their loss. When there are limited funds available in the market along with interest rates that is unaffordable to most, it will affect the chances of borrowers to obtain financing and lead to a higher risk to most of the corporate and individual’s exposure to bankruptcy. Finally, credit available in the market had become lesser and lead to the boom of the credit crisis (Investopedia, 2013). The financial crisis of 2007-2008 with the failure of Lehman Brothers is a great illustration of the credit crisis. A sudden change of the financial circumstance in the credit market had started a global financial crisis which has left a significant effect almost every part across the financial world (YaleGlobal Online, 2013). After that, many researchers started to investigate the causes that lead to this credit crisis. Particularly, some of them argue that bank chief executive officer (CEO) incentives are the major factor that causes credit crisis.
Bank CEOs Incentives
Initially, bank CEO incentives are a kind of performance based bonus aligns with shareholder interest (John and Qian, 2003). Whereby, shareholders gain and falls will affect the incentives of the CEOs. Generally, bank CEO incentives structure has been blamed for leading to the happened of credit crisis because people assume that CEO with high incentives based take excessive risk which resulted poor return that affect the performance of the bank. However, different version of assumption does appear based on different researches. Some finds that there is evidence that showed inappropriate alignment in incentives played a role in encouraging excessive risks taking which contributed to crisis. Banks that have great alignment in incentives pay out large amount of reward to the executives for the project that seemed profit but at the end proved harmful to the banks (Turner, 2009). Meanwhile, according to Bebchuk, Cohen and Spamann (2009) investigation on the executive compensation of Bear Stearns and Lehman Brothers during the period of 2000-2008, they also support that managerial incentives generated by executive compensation programs by banks leading to the credit crisis. Along the results and data gather in each sections, they find out that the CEO and other top executive of these two firms as well cashed out large amounts of performance-based compensation along the year and the pay arrangements have led to the credit crisis because it encourage excessive risk taking. There are many of the decisions made by CEOs ultimately led...

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