When academics talk about executive compensation, they usually focus on the mismatch between pay incentives and the interests of shareholders. Back in 1990, Michael Jensen and Brian Murphy argued in a famous (and in some quarters infamous) HBR article that too many executives were paid “like bureaucrats” — that is, that their pay bore little relation to the returns they delivered to shareholders.

Then, after corporate boards responded in the 1990s by loading CEO pay packages with more and more stock options, Lucian Bebchuk and Jesse Fried made the case that top executives had captured the pay-setting process to wrest big rewards for themselves regardless of what happened to shareholders.

In both of these views, executive pay was beset by an agency problem — the agents (a.k.a. the executives) had set things up in a way that disadvantaged the principals (a.k.a, the shareholders). Lately, though, scholars looking into the link between bankers’ pay and the financial crisis have begun gathering evidence of another problem: At financial institutions, executives looking out for the best interest of shareholders can rain economic disaster on the rest of us.

I made my first acquaintance with this new line of research at a conference on governance and executive pay in the financial sector last month at Columbia University. Here’s a quick rundown of the relevant working papers:

In “Yesterday’s Heroes: Compensation and Creative Risk-Taking” (pdf), Jose Scheinkman and Harrison Hong of Princeton and Ing-Haw Cheng of the University of Michigan studied the link between compensation and risk-taking among financial firms and found that, yeah, CEOs who took bigger risks got paid more. But there was no evidence that they were putting anything over on shareholders: the high-pay, high-risk firms had high levels of insider ownership, big holdings by institutional investors and did no worse on governance metrics than other firms.

Similarly, in “Bank CEO Incentives and the Credit Crisis,” René Stulz of Ohio State and Rüdiger Fahlenbrach of the Swiss Finance Institute found that banks where CEOs incentives were most closely aligned with those of shareholders actually did worse in terms of stock returns and return on equity during the crisis.

In “The Probability of Default, Excessive Risk, and Executive Compensation: A Study of Financial Services Firms from 1995 to 2008” (pdf), Sudhakar Balachandran and Bruce Kogut of Columbia and Hitesh Harnal of UBS found that higher equity-based pay increased the probability of default among the 113 firms they studied, while non-equity pay (such as cash bonuses) was correlated with a lower risk of default.

In “Bank Owners or Bank Managers: Who is Keen on Risk? Evidence from the Financial Crisis,” Reint Gropp of the European Business School and Matthias Köhler of the Center for European Economic Research discovered that banks with more concentrated ownership (that is, banks where the biggest shareholders were big enough that they — and not managers — presumably called the shots) “had higher profits in the years before the crisis, and incurred larger losses and were more likely to require government assistance during the crisis compared to manager-controlled banks.”

At the conference, Columbia’s Patrick Bolton talked a little about why this was. He and Hamid Mehran of the New York Fed and Joel Shapiro of Oxford University are in the early stages of a project (pdf) examining the theory of executive compensation and risk-taking. The gist of their argument is that equity in a highly leveraged firm (banks and investment banks have debt-to-equity ratios that start at 10-to-1 and go much higher) is equivalent to a call option. That is, if the firm goes bust the equity holders only lose a little but if it does well they can reap huge rewards. So shareholders have every incentive to push executives at highly leveraged firms to take big risks (and executives with big equity stakes have every incentive to take big risks).

Given the systemic importance of financial institutions, which causes central banks and governments to bail them out when things go wrong, this is a serious problem — and its one not envisioned in the usual analyses of what’s wrong with executive pay. “Aligning manager interest with shareholder interest does not necessarily mean a sound or socially responsible policy,” Columbia Law Professor John Coffee said at the conference. And yet, as Coffee pointed out, a major plank of the financial reform package now being worked out by House and Senate negotiators is a series of reforms intended to give shareholders more say in how corporate managers are rewarded. Hmmmm.

(For those who can’t get enough of financial sector wonkery, hbr.org is currently hosting, and I’m participating in, an online debate on “Finance: The Way Forward.”)