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Wage of Failure: Executive Compensation at the Failed Icelandic Banks

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The 2008 Global Financial Crisis in Retrospect

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Abstract

Gudrun Johnsen studies the relationship between the compensation systems used by the Icelandic banks and the decisions made by the management that, among other factors, led to the disaster. Evidence was found of misreporting of key performance indicators. Banks’ leadership teams in all three banks engaged in a large scale market manipulation as staff option awards were used as a vehicle to falsify equity through inappropriate hedging of options via off-balance sheet SPVs, in addition to excessive lending to staff and favoured customers to purchase banks’ stocks with insufficient collateral backing. This behaviour helped meet bonus targets, derail financial supervisors and the investing public, while bringing and keeping incentive pay, in the form of stock and options, in the money. Loan portfolios in the failed banks were marked by excessive risk taking and funds were tunnelled to related parties.

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Notes

  1. 1.

    E. Talley and G. Johnsen, Corporate Governance, Executive Compensation and Securities Litigation (USC Law School, Olin Research Paper No. 04-7 2005 and USC CLEO Research Paper No. C04-4 2005); A.A. Röell and L. Peng. (2006, August). “Executive Pay, Earnings Manipulation and Shareholder Litigation.” AFA 2005 Philadelphia Meetings, ssrn.com/abstract=488148.

  2. 2.

    Special Investigation Commission (SIC), Pall Hreinsson et al. (eds.), The Causes and Events Leading Up to the Fall of the Icelandic Banks [original title: Rannsóknarnefnd Alþingis, Aðdragandi og orsakir falls íslensku bankanna og tengdir atburðir] (Reykjavik, 2010), vol. 7, pp. 222–227; Ministry of Industry, Business and Financial Affairs, “The Financial Crisis in Denmark—Causes, Consequences and Lessons,” in Jesper Rangvid (ed.) (Copenhagen, 2013), p. 32, em.dk/english/publications/2013/13-09-18-financial-crisis; The Financial Crisis Inquiry Commission, P. Angelides et al. (eds.), The Financial Crisis Inquiry Report (Washington, DC: U.S. Government Printing, 2011), p. 61; and Nyberg Report, Misjudging Risk: Causes of the Systemic Banking Crisis in Ireland (2011), p. 31.

  3. 3.

    Jensen and Meckling (1976). Under the Jensen and Meckling’s definition, agency costs include problems of hidden actions, hidden information, influence costs, and the costs of implementing institutional structures to deal with them.

  4. 4.

    SIC Report, Volume 3, Chapter 10, pp. 39 and 59.

  5. 5.

    SIC Report, Volume 3, Chapter 10, p. 59.

  6. 6.

    Morgunblaðið-newspaper, 5 January 2009, on-line article available at: https://www.mbl.is/vidskipti/frettir/2009/01/05/endurgreiddi_370_milljonir/.

  7. 7.

    SIC Report, Volume 3, Chapter 10, p. 92, testimony of Internal Auditor of Kaupthing, Mrs. Lilja Steinthorsdottir, before the SIC on September 7, 2009, p. 14.

  8. 8.

    SIC Report, Volume 3, Chapter 10, p. 92.

  9. 9.

    SIC Report, Volume 3, Chapter 10, p. 91.

  10. 10.

    SIC Report, Volume 3, Chapter 10, p. 52.

  11. 11.

    SIC Report, Volume 3, Chapter 10, p. 52.

  12. 12.

    SIC Report, Volume 3, Chapter 10, p. 92.

  13. 13.

    SIC Report, Volume 3, Chapter 10, p. 86.

  14. 14.

    Supreme Court Ruling: Special Prosecutor vs. Kaupthing management in several cases including nr. 145/2014.

  15. 15.

    SIC Report, Volume 3, Chapter 10, p. 87.

  16. 16.

    Economic Value Added = R − K * C; R—profit after interest and tax, K—Cost of Equity Capital based on CAPM, C—Total Equity of the Bank.

  17. 17.

    SIC Report, Volume 3, Chapter 10, p. 39.

  18. 18.

    SIC Report, Volume 3, Chapter 10, p. 42.

  19. 19.

    SIC Report, Volume 3, Chapter 10, p. 43.

  20. 20.

    District Court of Reykjavik, State Prosecutor vs. Hreidar Mar Sigurdsson and Z, nr. S-705/2016.

  21. 21.

    SIC Report, Volume 3, Chapter 10, p. 86.

  22. 22.

    SIC Report, Volume 3, Chapter 10, pp. 93–94, and Employment Contract Between Kaupthing Bank and Mr. Sigurdsson from 2006.

  23. 23.

    SIC Report, Volume 3, Chapter 10, p. 78.

  24. 24.

    SIC Report, Volume 3, Chapter 10, p. 86.

  25. 25.

    SIC Report, Volume 3, Chapter 10, p. 34.

  26. 26.

    SIC Report, Volume 3, Chapter 9, p. 18.

  27. 27.

    SIC Report, Volume 3, Chapter 9, pp. 19–20.

  28. 28.

    SIC Report, Volume 3, Chapter 10, p. 68.

  29. 29.

    Supreme Court of Iceland case nr. 495/2016.

  30. 30.

    District Court of Reykjavik case nr. S-193/2016.

References

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  • Morgunblaðið-news paper. (2009, January 5). On-line Article. Available at: https://www.mbl.is/vidskipti/frettir/2009/01/05/endurgreiddi_370_milljonir/.

  • Nyberg Report. (2011). Commission of Investigation into the Banking Sector in Ireland. Misjudging Risk: Causes of the Systemic Banking Crisis in Ireland, p. 31. Available at: http://www.bankinginquiry.gov.ie/Documents/Misjuding%20Risk%20-%20Causes%20of%20the%20Systemic%20Banking%20Crisis%20in%20Ireland.pdf.

  • Röell, A., & Peng, L. (2006, August). Executive Pay, Earnings Manipulation and Shareholder Litigation. AFA 2005 Philadelphia Meetings. ssrn.com/abstract=488148.

  • Special Investigation Commission (SIC), Hreinsson, P. et. al. (Eds.). (2010). The Causes and Events Leading up to the Fall of the Icelandic Banks [original title: Rannsóknarnefnd Alþingis, Aðdragandi og orsakir falls íslensku bankanna og tengdir atburðir] (Vol. 7, pp. 222–227). Reykjavik: SIC.

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  • The Financial Crisis Inquiry Commission, P. Angelides et al. (Eds.). (2001). The Financial Crisis Inquiry Report (p. 61). Washington, DC: U.S. Government Printing.

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Authors and Affiliations

  1. University of Iceland, Reykjavik, Iceland

    Gudrun Johnsen

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  1. Gudrun Johnsen
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Correspondence to Gudrun Johnsen .

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Editors and Affiliations

  1. Booth School of Business, University of Chicago, Chicago, IL, USA

    Robert Z. Aliber

  2. Department of Economics, University of Iceland, Reykjavik, Iceland

    Gylfi Zoega

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Johnsen, G. (2019). Wage of Failure: Executive Compensation at the Failed Icelandic Banks. In: Aliber, R., Zoega, G. (eds) The 2008 Global Financial Crisis in Retrospect. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-030-12395-6_13

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  • DOI: https://doi.org/10.1007/978-3-030-12395-6_13

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  • Publisher Name: Palgrave Macmillan, Cham

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