Bankers' compensation: Sprint swimming in short bonus pools?
The global financial crisis of 2007–2008 has given rise to new regulatory initiatives to put restrictions on the size and the term of bankers' pay. We revisit both theoretically and empirically the question of whether these regulations are justified. We model bonuses as a series of sequential call options on profits and show that they provide higher risk-taking incentives the shorter the time is between payments. However, using data on CEO bonuses at the end of 2006 and our model, we find no robust relationship between risk-taking incentives and US banks' stock returns during the global financial crisis. The crisis returns are related negatively to leverage and positively to the market-to-book equity ratio. Our findings suggest that regulating leverage would be more effective than regulating bankers' compensation.
|Date of creation:||15 Jan 2014|
|Date of revision:|
|Contact details of provider:|| Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland|
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