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Executive compensation and risk taking

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Author Info

  • Patrick Bolton
  • Hamid Mehran
  • Joel Shapiro

Abstract

This paper studies the connection between risk taking and executive compensation in financial institutions. A theoretical model of shareholders, debtholders, depositors, and an executive suggests that 1) in principle, excessive risk taking (in the form of risk shifting) may be addressed by basing compensation on both stock price and the price of debt (proxied by the credit default swap spread), but 2) shareholders may be unable to commit to designing compensation contracts in this way and indeed may not want to because of distortions introduced by either deposit insurance or naive debtholders. The paper then provides an empirical analysis that suggests that debt-like compensation for executives is believed by the market to reduce risk for financial institutions.

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Bibliographic Info

Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 456.

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Date of creation: 2010
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Handle: RePEc:fip:fednsr:456

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Related research

Keywords: Executives - Salaries ; Financial risk management ; Stock - Prices;

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References

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  1. Brander, J.A. & Poitevin, M., 1988. "Managerial Compensation And The Agency Costs Of Debt Finance," Cahiers de recherche, Centre interuniversitaire de recherche en économie quantitative, CIREQ 8827, Centre interuniversitaire de recherche en économie quantitative, CIREQ.
  2. Ing-Haw Cheng & Harrison Hong & Jose A. Scheinkman, 2010. "Yesterday's Heroes: Compensation and Creative Risk-Taking," NBER Working Papers 16176, National Bureau of Economic Research, Inc.
  3. Smith, Clifford Jr. & Watts, Ross L., 1992. "The investment opportunity set and corporate financing, dividend, and compensation policies," Journal of Financial Economics, Elsevier, Elsevier, vol. 32(3), pages 263-292, December.
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  1. Executive compensation in the United States in Wikipedia English ne '')

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