Lucian Bebchuk, Alma Cohen, and Holger Spamann explain how executive pay at investment banks helped precipitate the crisis:
Our analysis undermines the claims that executives’ losses on shares during the collapses establish that they did not have incentives to take excessive risks. The fact that the executives did not sell all the shares they could prior to the meltdown does indicate that they did not anticipate collapse in the near future. But repeatedly cashing in large amounts of performance-based compensation based on short-term results did provide perverse incentives – incentives to improve short-term results even at the cost of an excessive rise in the risk of large losses at some (uncertain) point in the future.
Jeffrey Friedman, and those like Tyler Cowen who agree with him, are still welcome to believe that pay wasn’t a factor in the crisis. But I think they have to admit at this point that there is a coherent argument to push back against, rather than simply asserting, as Friedman does, that there’s no argument there at all. (Of course no one is saying that executive pay was the biggest factor. But I think there’s a colorable case that it played an important-if-not-decisive role.)