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Regulatory Restraints on Performance-Based Managerial Compensation, Bank Monitoring, and Aggregate Loan Quality

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  • David VanHoose

Abstract

This paper evaluates the effects of binding regulatory restraints on the rate of performance-based management compensation within a banking framework in which the primary function of bank management teams is to monitor loans in order to eliminate deadweight default losses. Available management teams are endowed with heterogeneous levels of monitoring efficiencies, and obtaining services from more efficient monitoring teams requires payment of higher rates of performance-based compensation. In equilibrium, a fraction of banks choose to employ management teams that monitor. With or without binding capital requirements, imposing binding restraints on the allowed rate of performance-based compensation results either in lower bank efficiency or in a reduced fraction of monitoring banks and, hence, lower aggregate loan quality.

Suggested Citation

  • David VanHoose, 2011. "Regulatory Restraints on Performance-Based Managerial Compensation, Bank Monitoring, and Aggregate Loan Quality," NFI Working Papers 2011-WP-02, Indiana State University, Scott College of Business, Networks Financial Institute.
    • Handle: RePEc:nfi:nfiwps:2011-wp-02
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    File URL: http://www.indstate.edu/business/sites/business.indstate.edu/files/Docs/2011-WP-02_VanHoose.pdf
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    References listed on IDEAS

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    1. John A. Tatom (ed.), 2011. "Financial Market Regulation," Springer Books, Springer, edition 1, number 978-1-4419-6637-7, September.
    2. John, Kose & Saunders, Anthony & Senbet, Lemma W, 2000. "A Theory of Bank Regulation and Management Compensation," The Review of Financial Studies, Society for Financial Studies, vol. 13(1), pages 95-125.
    3. Douglas W. Diamond, 1984. "Financial Intermediation and Delegated Monitoring," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 51(3), pages 393-414.
    4. Jonathan R. Macey & Maureen O'Hara, 2003. "The corporate governance of banks," Economic Policy Review, Federal Reserve Bank of New York, vol. 9(Apr), pages 91-107.
    5. Kopecky, Kenneth J. & VanHoose, David, 2006. "Capital regulation, heterogeneous monitoring costs, and aggregate loan quality," Journal of Banking & Finance, Elsevier, vol. 30(8), pages 2235-2255, August.
    6. Elyasiani, Elyas & Kopecky, Kenneth J & VanHoose, David, 1995. "Costs of Adjustment, Portfolio Separation, and the Dynamic Behavior of Bank Loans and Deposits," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(4), pages 955-974, November.
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    Cited by:

    1. John A. Tatom & Terrie Troxel, 2011. "A Report to the Federal Insurance Office," NFI Policy Briefs 2011-PB-07, Indiana State University, Scott College of Business, Networks Financial Institute.

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    More about this item

    Keywords

    Bank management compensation;

    JEL classification:

    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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