III. Applying the Subsidiarity Methodology to International Financial Regulation Cooperation

In this section, I examine how the reasons for international cooperation, issues of fragmentation, and expected future developments, all discussed above, affect possible regulation of (i) executive compensation; (ii) capital regulation; (iii) powers regulation; (iv) safety nets, bailouts and resolution; (v) disclosure; and (vi) rating agencies. Here, given an understanding about national policy in light of what we now know about the crisis and expected changes, we are able to evaluate the possible utility of international cooperation.

A. Corporate governance and compensation

In connection with existing and proposed caps on bankers’ pay, banks have argued that caps in one jurisdiction will cause highly skilled personnel to move to jurisdictions that lack caps. Given the competition among financial centres for the tax revenues, economic growth benefits and prestige that comes with dominance as a financial centre, it is not difficult to imagine that states would find it difficult to impose pay caps unilaterally, at least over the long term. Failure of states to coordinate with respect to pay caps would be a test of whether the market, supplemented by corporate governance systems, is capable of providing adequate discipline with respect to compensation.

If it were possible to devise compensation systems that provide adequate incentives for performance, without the incentives for taking on excessive risk, then, assuming effective corporate governance or market mechanisms, we would expect investors to discipline firms using these mechanisms and to avoid excessive com- pensation.[1] Market disciplines by virtue of investor voice or exit seem to have failed to prevent corporate governance problems. Nor has regulatory competition provided an effective response.

It might be argued that if it is impossible for the market to devise such systems, then it is likely to be equally impossible for governments to square that particular circle. Therefore, this argument would run, governmentally imposed caps are likely to provide inefficiently low incentives for performance. Whether compensation restrictions are, nevertheless, valuable because they also avoid offering excessive incentives to take on risk would depend on the magnitude of each effect. An opposing argument would point to information asymmetries that make it difficult for shareholders to evaluate the effects of compensation arrangements, or broader social externalities that would not be taken into account by shareholders in policing compensation arrangements. Corporate governance problems might have prevented the development of systems under which leading executives would have been required to bear risk, such as systems providing for deferred payment of bonuses in the form of equity or subordinated debt, with retention obligations.[2] Finally, the correct blend of incentives would depend to some extent on the social, legal and financial context in which each firm operates. There is, therefore, likely to be some cross-national diversity in the optimal response.

So, in order to craft an appropriate international response, it would be necessary to balance the utility of cross-national diversity, plus the utility of beneficial regulatory competition and experimentation that might yield a superior solution, against the possibility of adverse regulatory competition that might yield insufficient discipline on compensation. The process of negotiating an international regime would help to establish the right balance, most likely in terms of essential harmonization allowing a degree of national diversity.

To the extent that the financial crisis can be understood as a failure of corporate governance, or of other national financial regulation, it suggests that mere market forces harnessed to regulatory competition are insufficient to ensure a good result. In a very real sense, we have now experienced the results of a laissez-faire approach to regulatory competition, and have found them starkly unattractive. After all, in the run-up to the crisis, investors did not broadly migrate from US to Canadian mortgage-backed securities, nor did they migrate to investments in firms that had sufficient capital or that avoided risky investments.

  • [1] But see George Akerlof and Rachel Kranton, ‘It is Time to Treat Wall Street Like Main Street’,Financial Times, 24 February 2010 (arguing that incentive compensation is less likely to improveperformance than is commonly thought).
  • [2] See Financial Stability Board, ‘Financial Stability Board Principles for Sound CompensationPractices’, 2 April 2009, (visited16 July 2010).
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