An Unfortunate “Tail”: Reconsidering Risk Management Incentives After the Financial Crisis of 2007–2009

Douglas O. Edward

In recent months, the legal academic community has taken a greater interest in the practice of risk management.  Doubtless a response to the recent financial crisis, many have concluded that our current market structure allows for uninhibited risk taking and the pooling of systemic risk.  Accordingly, most have suggested a regulatory response is necessary.  This Comment, in unreserved agreement with these writers, attempts to contribute to this literature in two ways.

First, this Comment explains the development of quantitative risk management to fill in the gaps in the existing legal research.  Though I present nothing groundbreaking, my purpose is to provide legal professionals with a brief but not overwhelming account of the industry’s recent rise to power.  Following this initial discussion, I then return to the current risk-management debate and, making a second contribution to the recent academic literature, I build on the incentive modeling and regulatory suggestions presented by Professor Karl Okamoto is his recent article, After the Bailout: Regulating Systemic Moral Hazard.  In pertinent part, I recommend that policymakers implement a new disclosure regime and a compensation clawback private right of action to realign informational incentives in risk-based decision making.In the end, this Comment in no way seeks to be the last word in this discussion.  And, with luck, I hope that it will not be.  The recent financial crisis has exposed more than a few shortcomings in our financial regulation latticework, and we would do well to honestly discuss these limitations.  Though politically less palatable than the previous century’s approach to financial regulation, it may be time to seriously consider regulating not only executive compensation, but secondary manager compensation.  As this Comment suggests, much ill-advised wrongdoing can be captured by making these difficult decisions.