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Crisis Contracts

Author

Listed:
  • Elias Aptus

    (CER-ETH – Center of Economic Research at ETH Zurich)

  • Volker Britz

    (CER-ETH – Center of Economic Research at ETH Zurich)

  • Hans Gersbach

    (CER-ETH – Center of Economic Research at ETH Zurich
    CEPR)

Abstract

We examine the impact of so-called Crisis Contracts. Under a Crisis Contract, bank managers are required to contribute a pre-specified share of their past earnings to finance public rescue funds when a crisis occurs. This leads to a form of collective responsibility for bank managers. We develop a game-theoretic model of a banking sector whose shareholders have limited liability. Without Crisis Contracts, the managers’ and shareholders’ interests are aligned, and managers take more than the socially optimal level of risk, so that a socially costly crisis may occur. Crisis Contracts change the equilibrium level of risk-taking and the remuneration of bank managers. We establish conditions under which the introduction of Crisis Contracts reduces the probability of a banking crisis and improves social welfare. We explore how Crisis Contracts and capital requirements can supplement each other and we show that the effectiveness of Crisis Contracts is not undermined by attempts to hedge.

Suggested Citation

  • Elias Aptus & Volker Britz & Hans Gersbach, 2020. "Crisis Contracts," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 70(1), pages 121-164, July.
  • Handle: RePEc:spr:joecth:v:70:y:2020:i:1:d:10.1007_s00199-019-01204-9
    DOI: 10.1007/s00199-019-01204-9
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    References listed on IDEAS

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    More about this item

    Keywords

    Banking crises; Crisis Contracts; Excessive risk taking; Bankers’ pay; Hedging; Capital requirements;
    All these keywords.

    JEL classification:

    • C79 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Other
    • 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

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