505. Lucian Bebchuk & Jesse Fried, Executive Compensation at Fannie Mae: A Case Study of Perverse Incentives, Nonperformance Pay, and Camouflage, 02/2005; subsequently published in Journal of Corporation Law, Vol. 30, No. 14, Summer 2005, 807-822.
Abstract: This paper examines Fannie Mae’s executive compensation arrangements during the period 2000-2004. We identify and analyze four problems with these arrangements. First, by richly rewarding executives for reporting higher earnings, without requiring return of the compensation if earnings turned out to be misstated, Fannie Mae’s arrangements provided perverse incentives to inflate earnings. Second, Fannie Mae’s arrangements provided soft landings to executives who were pushed out by the board for failure; expectation of such outcome adversely affected ex ante incentives. Third, even if the executives had retired after years of unblemished service, the value of their retirement packages would have been largely unrelated to their own performance while in office, weakening the link between pay and performance. Fourth, both when promising retirement payments to executives and when making these payments, Fannie Mae’s disclosures obscured rather than made transparent the total values of the executives’ retirement packages. Because many other companies have practices similar to Fannie Mae’s, our study highlights some general problems with existing pay practices and the need for reform.