The debate about knee-jerk financial regulation will continue at the World Economic Forum in Davos this week

Dubai, UAE, 23 January 2014 – The debate about knee-jerk financial regulation will continue at the World Economic Forum in Davos this week, according to Alex Edmans, Professor of Finance, London Business School.

The financial crisis has led to sweeping reforms, such as the Dodd-Frank Act to increase regulatory oversight, and the Volcker Rule to restrict banks from engaging in proprietary trading.  But many commentators are concerned that these regulations are a knee-jerk reaction to public anger with financial institutions – that policymakers felt pressure to do something, rather than doing the right thing.

Professor Edmans is co-leading a session at Davos and is available for interview.

Alex Edmans, Professor of Finance, London Business School, visiting from The Wharton School, says: “These regulations may unduly restrict banks from pursuing their core social function – lending to finance growth and investment.  They may actually increase the likelihood of another crisis by failing to target the root cause.  For example, the European Union has capped bankers' bonuses at no more than their annual salary, or twice the annual salary with shareholders' approval.  This has led to banks increasing their base salaries, which is exactly the wrong way to prevent future crises. While bonuses can be lowered in a crisis, helping a bank to stay solvent, base salaries are much harder to lower. 

“More generally, it is not clear that compensation caused the crisis to begin with – Lehman was arguably the bank closest to the compensation model advocated by reformers, with employees holding substantial stakes in their firm.  Pay has far less effect on society than many other corporate decisions (mergers, investments, dividends, capital structure) yet is regulated most of all as this is popular with voters.  I will be very interested to hear Davos participants' views on how to take a measured approach to regulation, what regulations they feel are indeed justified in the light of the crisis, and which should perhaps be reversed.”