76 The Open Ethics Journal, 2009, 3, 76-80 1874-7612/09 2009 Bentham Open Open Access Pay Now, Lose Later: The Role of Bonuses and Non-Equity Incentives in the Financial Meltdown of 2007-2009 Dan Palmon, Michael A. Santoro * and Ron Strauss Rutgers Business School, One Washington Park, Newark, NJ 07102, USA Abstract: This paper draws attention to and raises questions about an area of executive incentive compensation, bonuses and non-equity incentives, which seems to have disproportionally rewarded executives while shareholders remain exposed to substantial ongoing economic risks. This area of focus has surfaced because, beginning in 2007 and continuing throughout 2008, financial services firms incurred massive losses, while in the years immediately preceding this deluge of losses many executives were awarded substantial bonuses and non-equity incentives. We assess the risks associated with such payments and build a framework for assessing how shareholder and executive interests diverge as a result of bonuses and non-equity compensation. Our analysis is also meant to serve as a building block for future empirical studies about the relationship between executive incentive compensation paid in cash (bonuses and non-equity incentives) and the financial misstatements and overstatements of income that were at the heart of the financial meltdown. INTRODUCTION The financial and economic crisis that is currently ripping across the United States (US) as well as the globe has destroyed vast amounts of wealth and economic prosper- ity and has sparked major actions by governments, financial institutions, companies and individuals in an attempt to cope with the economic destruction and devastation. Many efforts are being directed at both coping with the crisis as well as exploring questions that have surfaced as a result of a significantly shifted landscape. This new landscape allows for new perspectives which can expose previously underes- timated limitations, risks and flaws that have been part of generally accepted business practices and assumptions. Our effort here is directed at drawing attention to and raising questions about an area of executive incentive com- pensation that seems to have disproportionally rewarded executives while exposing shareholders to substantial ongoing economic risks, i.e. cash-based executive incentives. Cash incentives, which result from bonus plans and non- equity incentive plans, become risk-free to those executives once they receive the cash. However, shareholders continue to bear the economic risk of companies not actually realizing in cash the publicly reported corporate earnings, as well as related asset values, which putatively provided the basis for the incentive compensation payments. We explore the rationale for the cash bonuses and non-equity incentives as well as the implications and appropriateness of executives receiving such incentive payments while shareholders remain exposed to ongoing economic risk. *Address correspondence to this author at the Department of Accounting, Business Ethics & Information Systems, Rutgers Business School, One Washington Park, Newark, NJ 07102, USA; Tel: (973) 353-5121; Fax: (973) 353-1283; E-mail: msantoro@business.rutgers.edu This area of focus has surfaced because, beginning in 2007 and continuing throughout 2008, many firms in the financial services industry have incurred enormous losses while in the years immediately preceding this deluge of losses many executives received substantial cash incentive payments. Although these executive incentives were paid in cash, the earnings and related asset valuations, that were the basis for the payments, contained substantial ongoing economic risk for shareholders. The fact is that these ongo- ing economic risks became actual losses as a result of the now well understood economic consequences associated with the meltdown of the mortgage market. We frame an empirical approach for understanding and evaluating the relationship between executive incentives paid in cash, and reported profits - profits that turned out not only to be misstated but in several cases overstated by many multiples. The ultimate question we seek to illuminate in this and further work is whether and in what ways the compensation mechanism contributed to the misstatements and over- statements of income? Excessive executive compensation, particularly excessive total compensation has been and continues to be an active stream of research [1]. We bring a more targeted emphasis to the bonus and non-equity component of executive compen- sation with the objective of touting the importance of empirical research on the nature of the economic risk trans- ference which occurs when executive incentives are awarded in cash. EXECUTIVE COMPENSATION Executive compensation in the financial industry gener- ally is comprised of an annual base salary component and an executive incentive compensation component. While base salary is normally paid in cash, incentives can take a variety