Did stock options cause the recession? - 6 August 2009

From Michael Mandel:

http://weblogs.baltimoresun.com/business/hancock/blog/2009/08/did_stock_options_cause_the_re.html

A new academic paper makes a credible argument that stock
option contracts for executives can cause excessively large swings in
the economy. The paper,
which I think is destined to become a classic, has a great title: "Some
Unpleasant General Equilibrium Implications of Executive Incentive
Compensation Contracts. "

The idea is that bubbles are driven by "self-fulfilling fluctuations
in the manager's expectations," according to the paper by John
Donaldson, Natalia Gershun and Marc Giannoni. And the pay of those
managers is disproportionally driven by the growth of the firm, so
they're prone to overexpand. The thinking among economists until
recently was that computers had eased booms and busts. When Walmart's
cash registers can instantly talk to the factories of Walmart's
vendors, the thinking went, the risk of production gluts and the
resulting slumps should be less. That still makes sense. But maybe
heavily incentivized and self-deluded executives are now a
countervailing force.

The paper's conclusion:

These results suggest that the early twenty-first century
explosion in the incentive compensation among financial firms may have
unforeseen consequences. We are only now beginning to see what these
consequences are.