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Bank of Finland Research Discussion Papers, Bank of Finland

No 2/2014:
Bankers' compensation: Sprint swimming in short bonus pools?

Esa Jokivuolle () and Jussi Keppo ()

Abstract: The global financial crisis of 20072008 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.

Keywords: banking; bonuses; regulation; compensation; (follow links to similar papers)

JEL-Codes: G01; G21; G28; J33; M52; (follow links to similar papers)

40 pages, January 15, 2014

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