Question

Describe how compensation systems encouraged risk. Be specific. Briefly explain how these compensations systems contributed to what the author calls "the fragile house of cards upon which the American financial system was built."

Answer 1

Based on the research conducted by the KPMG and other firms, it has become clear that financial crisis of 2008 was accelerated and prolonged by the incentive compensation.

Compensation led to the high risky activities by the firms. Managers tend to take up risky activities when they are offered incentive compensations. Thus, these firms eventually invested in risky activities which could have been averted in absence of perverted incentives.

Thus incentive compensation made American financial system fragile and relatively unstable.