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Optimal bonuses and deferred pay for bank employees : implications of hidden actions with persistent effects in time

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  • Arantxa Jarque
  • Edward Simpson Prescott

Abstract

We present a sequence of two-period models of incentive-based compensation in order to understand how the properties of optimal compensation structures vary with changes in the model environment. Each model corresponds to a different occupation within a bank, such as credit line managers, loan originators, or traders. All models share a common trait: the effects of hidden actions are persistent, and hence are revealed over time. We characterize the corresponding optimal contracts that are consistent with prudent risk taking. We compare the contracts by ranking them according to the average wage, the proportion of deferred compensation, and the structure and importance of variable pay (bonuses). We also compare these characteristics of the models with persistence with those of a standard repeated moral hazard. We find that small changes in the structure of asymmetric information have important implications for the characteristics of optimal pay, and that persistence does not necessarily imply a higher proportion of deferred pay.

Suggested Citation

  • Arantxa Jarque & Edward Simpson Prescott, 2010. "Optimal bonuses and deferred pay for bank employees : implications of hidden actions with persistent effects in time," Working Paper 10-16, Federal Reserve Bank of Richmond.
    • Handle: RePEc:fip:fedrwp:10-16
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    Cited by:

    1. Cziraki, Peter, 2018. "Trading by bank insiders before and during the 2007–2008 financial crisis," Journal of Financial Intermediation, Elsevier, vol. 33(C), pages 58-82.
    2. Eberhard Feess & Ansgar Wohlschlegel, 2018. "Bank capital requirements and mandatory deferral of compensation," Journal of Regulatory Economics, Springer, vol. 53(2), pages 206-242, April.
    3. Arantxa Jarque & Edward Simpson Prescott, 2013. "Banker compensation and bank risk taking: the organizational economics view," Working Paper 13-03, Federal Reserve Bank of Richmond.
    4. Borys Grochulski, 2011. "Financial firm resolution policy as a time-consistency problem," Economic Quarterly, Federal Reserve Bank of Richmond, vol. 97(2Q), pages 133-152.
    5. Jarque, Arantxa & Prescott, Edward Simpson, 2020. "Banker compensation, relative performance, and bank risk," Journal of the Japanese and International Economies, Elsevier, vol. 56(C).

    More about this item

    Keywords

    Financial institutions; Financial markets; Labor market; Moral hazard;
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