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Privatized Returns and Socialized Risks: CEO Incentives, Securitization Accounting and the Financial Crisis

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  • Fabrizi, M.
  • Parbonetti, A.
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    Abstract

    The paper investigates the role of CEO’s equity and risk incentives in boosting securitization in the financial industry and in motivating executives to reduce the perceived risk while betting on it. Using a sample of US financial institutions over the period 2003-2009 we document that CEOs with high equity incentives have systematically engaged in securitization transactions to a larger extent than CEOs with low incentives. We also show that CEOs with high equity and risk-related incentives have engaged in the securitization of risky loans and have used securitization for transferring risks to outside investors. Finally, we show that executives incentivized on risk have provided outside investors with low quality disclosure about losses recorded on securitized loans thus contributing to increase the opacity of securitization transactions undertaken. Overall, we interpret our results as evidence that CEOs have foreseen in securitizations under US GAAP an opportunity for hiding risks while bearing them and generating profits and cash flows because of the risks. Our results are robust to several model specifications as well as to endogeneity concerns.

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    File URL: http://openaccess.city.ac.uk/2120/1/CITYPERC%2DWPS%2D2013_08.pdf
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    Bibliographic Info

    Paper provided by Department of International Politics, City University London in its series CITYPERC Working Paper Series with number 2013-08.

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    Date of creation: 2013
    Date of revision:
    Handle: RePEc:dip:dpaper:2013-08

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    Postal: Department of International Politics, Social Sciences Building, City University London, Whiskin Street, London, EC1R 0JD, United Kingdom
    Phone: +44 (0)20 7040 8500
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    Web page: http://www.city.ac.uk/arts-social-sciences/international-politics/
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    Related research

    Keywords: Executive compensation; CEO incentives; Securitization; Financial Crisis;

    This paper has been announced in the following NEP Reports:

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    1. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
    2. Rüdiger FAHLENBRACH & René M. STULZ, . "Bank CEO Incentives and the Credit Crisis," Swiss Finance Institute Research Paper Series 09-27, Swiss Finance Institute.
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    7. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-70, May.
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    9. Smith, Clifford W. & Stulz, René M., 1985. "The Determinants of Firms' Hedging Policies," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 20(04), pages 391-405, December.
    10. Adam B. Ashcraft & Til Schuermann, 2008. "Understanding the securitization of subprime mortgage credit," Staff Reports 318, Federal Reserve Bank of New York.
    11. Daniel A. Rogers, 2005. "Managerial Risk-Taking Incentives and Executive Stock Option Repricing: A Study of US Casino Executives," Financial Management, Financial Management Association, vol. 34(1), Spring.
    12. Raghuram G. Rajan, 2006. "Has Finance Made the World Riskier?," European Financial Management, European Financial Management Association, vol. 12(4), pages 499-533.
    13. John Core, 2002. "Estimating the Value of Employee Stock Option Portfolios and Their Sensitivities to Price and Volatility," Journal of Accounting Research, Wiley Blackwell, vol. 40(3), pages 613-630, 06.
    14. Coles, Jeffrey L. & Daniel, Naveen D. & Naveen, Lalitha, 2006. "Managerial incentives and risk-taking," Journal of Financial Economics, Elsevier, vol. 79(2), pages 431-468, February.
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