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A Theory of Bank Regulation and Management Compensation

  • Kose John
  • Anthony Saunders
  • Lemma W. Senbet

This paper examines the incentive structure underlying the current features of bank regulation. We show that capital regulation has limited effectiveness, given the observed high leverage ratios of banks. We propose instead a more direct and effective mechanism of influencing incentives through the role of top-management compensation, whereby a fair and revenue-neutral FDIC premium incorporates incentive features of top-management compensation. With this pricing scheme (for FDIC insurance), we show that bank owners choose an optimal management compensation structure which induces first-best value-maximizing investment choices by a bank's management. We also characterize the parameters of the optimal managerial compensation structure and the FDIC premium schedule explicitly.

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Paper provided by New York University, Leonard N. Stern School of Business- in its series New York University, Leonard N. Stern School Finance Department Working Paper Seires with number 96-30.

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Date of creation: Sep 1996
Date of revision:
Handle: RePEc:fth:nystfi:96-30
Contact details of provider: Postal: U.S.A.; New York University, Leonard N. Stern School of Business, Department of Economics . 44 West 4th Street. New York, New York 10012-1126
Phone: (212) 998-0100
Web page: http://w4.stern.nyu.edu/finance/
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