Research Discussion Papers, Bank of Finland
Bankers' compensation: Sprint swimming in short bonus pools?
() and Jussi Keppo
Abstract: 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.
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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