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Incentivizing calculated risk-taking :evidence from an experiment with commercial bank loan officers

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  • Cole, Shawn
  • Kanz, Martin
  • Klapper, Leora

Abstract

This paper uses a series of experiments with commercial bank loan officers to test the effect of performance incentives on risk-assessment and lending decisions. The paper first shows that, while high-powered incentives lead to greater screening effort and more profitable lending, their power is muted by both deferred compensation and the limited liability typically enjoyed by loan officers. Second, the paper presents direct evidence that incentive contracts distort judgment and beliefs, even among trained professionals with many years of experience. Loans evaluated under more permissive incentive schemes are rated significantly less risky than the same loans evaluated under pay-for-performance.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 6146.

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Date of creation: 01 Jul 2012
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Handle: RePEc:wbk:wbrwps:6146

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Keywords: Debt Markets; Access to Finance; Bankruptcy and Resolution of Financial Distress; Banks&Banking Reform; Microfinance;

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References

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  1. Heider, Florian & Inderst, Roman, 2012. "Loan prospecting," Working Paper Series 1439, European Central Bank.
  2. Dell''Ariccia, Giovanni & Marquez, Robert, 2005. "Lending Booms and Lending Standards," CEPR Discussion Papers 5095, C.E.P.R. Discussion Papers.
  3. Pierre-Olivier Gourinchas & Rodrigo Valdes & Oscar Landerretche, 2001. "Lending Booms: Latin America and the World," Journal of LACEA Economia, LACEA - LATIN AMERICAN AND CARIBBEAN ECONOMIC ASSOCIATION.
  4. Patrick Bolton & Hamid Mehran & Joel Shapiro, 2010. "Executive compensation and risk taking," Staff Reports 456, Federal Reserve Bank of New York.
  5. Steven D. Levitt & John A. List, 2007. "What Do Laboratory Experiments Measuring Social Preferences Reveal About the Real World?," Journal of Economic Perspectives, American Economic Association, vol. 21(2), pages 153-174, Spring.
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  7. Giovanni Dell'Ariccia & Luc Laeven & Deniz Igan, 2008. "Credit Booms and Lending Standards: Evidence from the Subprime Mortgage Market," IMF Working Papers 08/106, International Monetary Fund.
  8. Glenn Harrison & John List & Charles Towe, 2004. "Naturally occurring preferences and exogenous laboratory experiments: A case study of risk aversion," Framed Field Experiments 00155, The Field Experiments Website.
  9. Andrew Hertzberg & Jose Maria Liberti & Daniel Paravisini, 2010. "Information and Incentives Inside the Firm: Evidence from Loan Officer Rotation," Journal of Finance, American Finance Association, vol. 65(3), pages 795-828, 06.
  10. Allen N. Berger & Leora F. Klapper & Gregory F. Udell, 2001. "The ability of banks to lend to informationally opaque small businesses," Finance and Economics Discussion Series 2001-34, Board of Governors of the Federal Reserve System (U.S.).
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  16. Shawn A. Cole, 2007. "Financial Development, Bank Ownership, and Growth. Or, Does Quantity Imply Quality?," Harvard Business School Working Papers 09-002, Harvard Business School.
  17. Murphy, Kevin J., 1999. "Executive compensation," Handbook of Labor Economics, in: O. Ashenfelter & D. Card (ed.), Handbook of Labor Economics, edition 1, volume 3, chapter 38, pages 2485-2563 Elsevier.
  18. 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.
  19. Bernheim, B Douglas, 1994. "A Theory of Conformity," Journal of Political Economy, University of Chicago Press, vol. 102(5), pages 841-77, October.
  20. de Mel, Suresh & McKenzie, David & Woodruff, Christopher, 2009. "Innovative firms or innovative owners ? determinants of innovation in micro, small, and medium enterprises," Policy Research Working Paper Series 4934, The World Bank.
  21. Bandiera, Oriana & Barankay, Iwan & Rasul, Imran, 2006. "Incentives for Managers and Inequality Among Workers: Evidence from a Firm Level Experiment," IZA Discussion Papers 2062, Institute for the Study of Labor (IZA).
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  23. Jose Maria Liberti, 2004. "Initiative, Incentives and Soft Information. How Does Delegation Impact The Role of Bank Relationship Managers?," Finance 0404023, EconWPA.
  24. Benjamin J. Keys & Tanmoy Mukherjee & Amit Seru & Vikrant Vig, 2010. "Did Securitization Lead to Lax Screening? Evidence from Subprime Loans," The Quarterly Journal of Economics, MIT Press, vol. 125(1), pages 307-362, February.
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Citations

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. Ing-Haw Cheng & Sahil Raina & Wei Xiong, 2013. "Wall Street and the Housing Bubble," NBER Working Papers 18904, National Bureau of Economic Research, Inc.
  2. Thorsten Beck & Patrick Behr & Andreas Madestam, 2011. "Sex and Credit: Is There a Gender Bias in Lending?," Working Papers 411, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.

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