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Incentivizing Calculated Risk-Taking: Evidence from an Experiment with Commercial Bank Loan Officers

Author Info

Listed author(s):
  • Shawn Cole

    ()

    (Harvard Business School, Finance Unit)

  • Martin Kanz

    ()

    (World Bank)

  • Leora Klapper

    ()

    (World Bank)

Abstract

This paper uses a series of experiments with commercial bank loan officers to test the effect of performance incentives on risk-assessment and lending decisions. We first show that, while high-powered incentives lead to greater screening effort and more profitable lending, their power is muted by both deferred compensation and the limited liability typically enjoyed by credit officers. Second, we present direct evidence that incentive contracts distort judgment and beliefs, even among trained professionals with many years of experience. Loans evaluated under more permissive incentive schemes are rated significantly less risky than the same loans evaluated under pay-for-performance.

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File URL: http://www.hbs.edu/research/pdf/13-002.pdf
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Paper provided by Harvard Business School in its series Harvard Business School Working Papers with number 13-002.

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Length: 69 pages
Date of creation: Jul 2012
Handle: RePEc:hbs:wpaper:13-002
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Keywords: loan officer incentives; banking; emerging markets;

Other versions of this item:

Find related papers by JEL classification:
  • D03 - Microeconomics - - General - - - Behavioral Microeconomics: Underlying Principles
  • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
  • J22 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Time Allocation and Labor Supply
  • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods
  • L2 - Industrial Organization - - Firm Objectives, Organization, and Behavior

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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Bonuses and risk taking: Some experimental evidence to bolster commonsense
    by Nicholas Gruen in Club Troppo on 2012-07-15 04:36:00
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