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Risk-shifting and the regulation of bank CEOs’ compensation

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  • Chaigneau, Pierre

Abstract

This paper analyzes the effects of two regulatory mechanisms, namely a regulation of the structure of bank CEOs incentive pay and sanctions for the CEOs of failed banks, on bank risk shifting. We extend a standard model of CEO compensation by incorporating leverage and an investment decision. To the extent that bank depositors and creditors are even partially protected by public guarantees, we show that it is in the interests of bank shareholders to choose more risky investments than would be socially optimal, and therefore to design a CEO contract with excessive risk taking incentives. Thus, we argue that current corporate governance arrangements in the banking sector are not efficient. In this setting, we show that putting in place one of the aforementioned mechanisms could yield the socially optimal outcome at no cost. We also identify some limitations and potential perverse effects of these mechanisms.

Suggested Citation

  • Chaigneau, Pierre, 2013. "Risk-shifting and the regulation of bank CEOs’ compensation," Journal of Financial Stability, Elsevier, vol. 9(4), pages 778-789.
    • Handle: RePEc:eee:finsta:v:9:y:2013:i:4:p:778-789
    DOI: 10.1016/j.jfs.2012.08.003
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Albuquerque, Rui & Cabral, Luis & Guedes, Jose, 2016. "Relative Performance, Banker Compensation, and Systemic Risk," CEPR Discussion Papers 11693, C.E.P.R. Discussion Papers.
    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. repec:nms:untern:10.5771/0042-059x-2014-2-92 is not listed on IDEAS
    4. repec:oup:revfin:v:21:y:2017:i:5:p:1805-1846. is not listed on IDEAS
    5. Vittoria, Cerasi & Sebastian, Deininger & Leonardo, Gambacorta & Tommaso, Oliviero, 2017. "How post-crisis regulation has affected bank CEO compensation," Working Papers 365, University of Milano-Bicocca, Department of Economics, revised 28 Apr 2017.
    6. Chaiporn Vithessonthi, 2016. "The Consequences of Bank Loan Growth: Evidence from Asia," PIER Discussion Papers 19., Puey Ungphakorn Institute for Economic Research, revised Feb 2016.
    7. Gietl, Daniel, 2018. "Overconfidence and Bailouts," Rationality and Competition Discussion Paper Series 132, CRC TRR 190 Rationality and Competition.
    8. Carlos A. Arango & Oscar M. Valencia, 2015. "Macro-Prudential Policy under Moral Hazard and Financial Fragility," Borradores de Economia 878, Banco de la Republica de Colombia.
    9. repec:oup:rfinst:v:21:y:2017:i:5:p:1805-1846. is not listed on IDEAS
    10. Ingolf Dittmann & Ko-Chia Yu & Dan Zhang, 2017. "How Important Are Risk-Taking Incentives in Executive Compensation?," Review of Finance, European Finance Association, vol. 21(5), pages 1805-1846.
    11. Carlos Arango & Oscar Valencia, 2015. "Macro-prudential Policies, Moral Hazard and Financial Fragility," IHEID Working Papers 06-2015, Economics Section, The Graduate Institute of International Studies.

    More about this item

    Keywords

    Banking regulation; CEO incentives; Corporate governance; Moral hazard;

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods

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