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Relative Performance, Banker Compensation, and Systemic Risk

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  • Albuquerque, Rui
  • Cabral, Luis
  • Guedes, Jose

Abstract

This paper shows that in the presence of correlated investment opportunities across banks, risk sharing between bank shareholders and bank managers leads to compensation contracts that include relative performance evaluation and to investment decisions that are biased toward such correlated opportunities, thus creating systemic risk. We analyze various policy recommendations regarding bank managerial pay and show that shareholders optimally undo the intended risk-reducing effects of the policies, demonstrating their ineffectiveness in curbing systemic risk.

Suggested Citation

  • Albuquerque, Rui & Cabral, Luis & Guedes, Jose, 2016. "Relative Performance, Banker Compensation, and Systemic Risk," CEPR Discussion Papers 11693, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:11693
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    References listed on IDEAS

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