Reforming Financial Industry Executive Compensation Practices to Manage Risk, Build Long-Term Value, and Assure Legal Compliance: Lessons of the 'London Whale' Trade for Volcker Rule Implementation

How executive pay -- particularly cash-based incentive bonuses -- is structured can have as much if not greater consequences for firm-wide and systemic risk than the gross amount of executive pay. The public policy debate over executive pay in the banking sector has placed too much emphasis on whether executive pay is excessive and not enough on whether particular executive pay policies are constructed in a manner that protects the interests of shareholders and the public in risk management, long-term value creation, and legal compliance. After a brief general overview of executive compensation in the financial industry, this paper considers the role of cash-based executive compensation in the 2008 financial crisis. It then briefly surveys legal and industry-initiated reforms of executive compensation enacted or proposed to date. Finally, by examining the infamous London Whale trade at JPMorgan Chase, the chapter demonstrates the need for innovative approaches to executive compensation more closely aligned with risk mitigation and legal compliance with the Volcker Rule.