Everyone agrees that one of the primary causes for the collapse of Lehman Brothers and Merrill Lynch was excessive risk taking. Mortgage brokers and banks sold loans to extremely high-risk individuals and then packaged those debts into insanely complex derivative products that were bought and sold with little consideration of the risky foundation on which the products were based. Several errors and omissions by the compensation function played a major role in the excessive risk taking by loan officers and the buyers and sellers of mortgage derivatives. These are: 1. They give excessive rewards. 2. Compensation design failed to forecast the desired level of risk taking. 3. No penalties for failure. 4. No feedback loop after implementation. 5. They have a short-term perspective. 6. No skin in the game.
Comp collapse John Sullivan Workforce Management; Nov 3, 2008; 87, 18; Docstoc pg. 50 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
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