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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;

This paper has been announced in the following NEP Reports:

References

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  1. Brander, J.A. & Poitevin, M., 1988. "Managerial Compensation And The Agency Costs Of Debt Finance," Cahiers de recherche 8827, Centre interuniversitaire de recherche en économie quantitative, CIREQ.
  2. Smith, Clifford Jr. & Watts, Ross L., 1992. "The investment opportunity set and corporate financing, dividend, and compensation policies," Journal of Financial Economics, Elsevier, vol. 32(3), pages 263-292, December.
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Citations

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Cited by:
  1. Eufinger, Christian & Gill, Andrej, 2012. "Basel III and CEO compensation: a new regulation attempt after the crisis," Annual Conference 2012 (Goettingen): New Approaches and Challenges for the Labor Market of the 21st Century 62056, Verein für Socialpolitik / German Economic Association.
  2. Hans Bystrom, 2012. "Executive compensation based on asset values," Economics Bulletin, AccessEcon, vol. 32(2), pages 1504-1508.
  3. Shawn Cole & Martin Kanz & Leora Klapper, 2012. "Incentivizing Calculated Risk-Taking: Evidence from an Experiment with Commercial Bank Loan Officers," Harvard Business School Working Papers 13-002, Harvard Business School.
  4. Inderst, Roman & Pfeil, Sebastian, 2010. "Securitization and Compensation in Financial Institutions," CEPR Discussion Papers 8089, C.E.P.R. Discussion Papers.
  5. Besley, Timothy J. & Ghatak, Maitreesh, 2011. "Taxation and Regulation of Bonus Pay," CEPR Discussion Papers 8532, C.E.P.R. Discussion Papers.
  6. Piti Disyatat, 2012. "Discussion of Property Prices and Bank Risk-taking," RBA Annual Conference Volume, in: Alexandra Heath & Frank Packer & Callan Windsor (ed.), Property Markets and Financial Stability Reserve Bank of Australia.
  7. Admati, Anat R. & DeMarzo, Peter M. & Hellwig, Martin F. & Pfleiderer, Paul, 2010. "Fallacies, Irrelevant Facts, and Myths in the Discussion of Capital Regulation: Why Bank Equity Is Not Expensive," Research Papers 2065, Stanford University, Graduate School of Business.
  8. John Thanassoulis, 2011. "The Case For Intervening In Bankers' Pay," Economics Series Working Papers 532, University of Oxford, Department of Economics.

Lists

This item is featured on the following reading lists or Wikipedia pages:
  1. Executive compensation in Wikipedia (English)
  2. Executive compensation in the United States in Wikipedia (English)

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