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Bailouts, Bonuses and Bankers' Short-Termism

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  • Michael Hilmer

Abstract

Using a principal-agent model with two-periods, we analyze the effects of both bailouts and bonus taxation on managerial compensation and short-termism. In our model, short-termism increases expected short-term profits at the expense of expected long-term profits and is harmful not only for society, but also for the bank itself. By neglecting the costs of failure, an anticipated bailout induces the bank to tolerate short-termist behavior more often. In addition, existing excessive short-termism increases further in the anticipated bailout payment, while compensation shifts from long-term towards short-term compensation. However, an appropriate tax on short-term bonuses can induce the bank to internalize the costs of a bailout. Consequently, our model offers a rationale for such a tax when banks anticipate bailouts and adjust their compensation payments accordingly.

Suggested Citation

  • Michael Hilmer, 2014. "Bailouts, Bonuses and Bankers' Short-Termism," Working Papers tax-mpg-rps-2014-17, Max Planck Institute for Tax Law and Public Finance.
  • Handle: RePEc:mpi:wpaper:tax-mpg-rps-2014-17
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    More about this item

    Keywords

    Bonus Tax; Executive Compensation; Bonuses; Short-Termism; Bailout; Systemic Risk;
    All these keywords.

    JEL classification:

    • H24 - Public Economics - - Taxation, Subsidies, and Revenue - - - Personal Income and Other Nonbusiness Taxes and Subsidies
    • J3 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs
    • M52 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Personnel Economics - - - Compensation and Compensation Methods and Their Effects
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation

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