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Incentivizing Calculated Risk-Taking: Evidence from an Experiment with Commercial Bank Loan Officers

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  • Shawn Cole
  • Martin Kanz
  • Leora Klapper

Abstract

We use an experiment with commercial bank loan officers to test how performance based compensation affects risk-assessment and lending. High-powered incentives lead to greater screening effort and more profitable lending decisions. This effect, however, is muted by deferred compensation and limited liability, two standard features of loan officer incentive contracts. We find that career concerns and personality traits affect screening behavior, but show that the response to monetary incentives does not vary with traits such as risk-aversion, optimism or overconfidence. Finally, we present evidence that incentive contracts distort the assessment of credit risk, even among trained professionals with many years of experience. Loans evaluated under permissive incentives are rated significantly less risky than the same loans evaluated under pay-for-performance.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 19472.

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Date of creation: Sep 2013
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Handle: RePEc:nbr:nberwo:19472

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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Bonuses and risk taking: Some experimental evidence to bolster commonsense
    by Nicholas Gruen in Club Troppo on 2012-07-15 04:36:00
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Cited by:
  1. Beck, T.H.L. & Behr, P. & Madestam, A., 2012. "Sex and Credit: Is there a Gender Bias in Lending?," Discussion Paper 2012-062, Tilburg University, Center for Economic Research.
  2. Sumit Agarwal & Itzhak Ben-David, 2014. "Do Loan Officers’ Incentives Lead to Lax Lending Standards?," NBER Working Papers 19945, National Bureau of Economic Research, Inc.
  3. Ing-Haw Cheng & Sahil Raina & Wei Xiong, 2013. "Wall Street and the Housing Bubble," NBER Working Papers 18904, National Bureau of Economic Research, Inc.
  4. Tobias Berg & Manju Puri & Jorg Rocholl, 2013. "Loan officer Incentives and the Limits of Hard Information," NBER Working Papers 19051, National Bureau of Economic Research, Inc.

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