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Bank of Finland Research Discussion Papers, Bank of Finland

No 5/2015:
Bonus caps, deferrals and bankers' risk-taking

Esa Jokivuolle (), Jussi Keppo () and Xuchuan Yuan ()

Abstract: We model a banker's future bonuses as a series of call options on the bank's profits and show that bonus caps and deferrals reduce risk-taking. However, the banker's optimal risk-taking also depends on the costs of risk-taking. We calibrate the model to US banking data and show that lengthening the standard one-year bonus payment interval has no material impact, whereas capping the bonus at the level of the base salary substantially reduces the bankersí risk-taking. Our results suggest that the European Union's bonus cap reduces risk-taking whereas bonus clawbacks as prescribed in the Dodd-Frank Act appear to be ineffective.

Keywords: banking; bonuses; regulation; compensation; Dodd-Frank Act; (follow links to similar papers)

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

50 pages, March 4, 2015

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URN:NBN:fi:bof-201503041096    PDF-file
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