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 bankers’ 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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Full text versions of the paper:
URN:NBN:fi:bof-201503041096 
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