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CEO Compensation, Regulation, and Risk in Banks: Theory and Evidence from the Financial Crisis

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Listed:
  • Vittoria Cerasi

    (Bicocca University)

  • Tommaso Oliviero

    (CSEF)

Abstract

This paper studies the relation between CEOs’ monetary incentives, financial regulation, and risk in banks. We develop a model where banks lend to opaque entrepreneurial projects that need to be monitored by bank managers. Bank managers are remunerated according to a pay-for-performance scheme and their effort is not observable to depositors and bank shareholders. Within a prudential regulatory framework that imposes a minimum capital ratio and a deposit insurance scheme, we study the effect of increasing the variable component of managerial compensation on bank risk in equilibrium. We test the model’s predictions on a sample of large banks around the world, gauging how the monetary incentives for CEOs in 2006 affected their banks’ stock price and volatility during the 2007–8 financial crisis. Our international sample allows us to study the interaction between monetary incentives and financial regulation. We find that greater sensitivity of CEOs’ equity portfolios to stock prices and volatility is associated with poorer performance and greater risk at the banks where shareholder control is weaker and in countries with explicit deposit insurance.

Suggested Citation

  • Vittoria Cerasi & Tommaso Oliviero, 2015. "CEO Compensation, Regulation, and Risk in Banks: Theory and Evidence from the Financial Crisis," International Journal of Central Banking, International Journal of Central Banking, vol. 11(3), pages 241-297, June.
  • Handle: RePEc:ijc:ijcjou:y:2015:q:3:a:6
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    References listed on IDEAS

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    Cited by:

    1. Cerasi, Vittoria & Deininger, Sebastian M. & Gambacorta, Leonardo & Oliviero, Tommaso, 2020. "How post-crisis regulation has affected bank CEO compensation," Journal of International Money and Finance, Elsevier, vol. 104(C).
    2. Julian Kolm & Christian Laux & Gyöngyi Lóránth, 2017. "Bank Regulation, CEO Compensation, and Boards," Review of Finance, European Finance Association, vol. 21(5), pages 1901-1932.
    3. Abascal, Ramón & González, Francisco, 2023. "What drives risk-taking incentives embedded in bank executive compensation? Some international evidence," Journal of Corporate Finance, Elsevier, vol. 79(C).
    4. Kolasinski, Adam C. & Yang, Nan, 2018. "Managerial myopia and the mortgage meltdown," Journal of Financial Economics, Elsevier, vol. 128(3), pages 466-485.
    5. Djebali Nesrine, 2023. "Does governance matter for bank stability? “MENA region case”," Journal of Asset Management, Palgrave Macmillan, vol. 24(4), pages 312-328, July.
    6. Jennifer Kunz & Mathias Heitz, 2021. "Banks’ risk culture and management control systems: A systematic literature review," Journal of Management Control: Zeitschrift für Planung und Unternehmenssteuerung, Springer, vol. 32(4), pages 439-493, December.
    7. Abascal, Ramón & González, Francisco, 2019. "Shareholder protection and bank executive compensation after the global financial crisis," Journal of Financial Stability, Elsevier, vol. 40(C), pages 15-37.
    8. Nesrine Djebali & Khemais Zaghdoudi, 2020. "Testing the governance-performance relationship for the Tunisian banks: a GMM in system analysis," Financial Innovation, Springer;Southwestern University of Finance and Economics, vol. 6(1), pages 1-24, December.
    9. Alberto Razul & Orlando Gomes & Mohamed Azzim Gulamhussen, 2024. "Bonuses, options, and bank strategies," SN Business & Economics, Springer, vol. 4(1), pages 1-28, January.

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    More about this item

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation

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