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Edited by James R. Barth, Chen Lin and Clas Wihlborg
Chapter 9: CEO Pay and Risk-taking in Banking: The Roles of Bonus Plans and Deferred Compensation in Curbing Bank Risk-taking
Jens Hagendorff and Francesco Vallascas 9.1 INTRODUCTION Executive compensation policy may serve as a mechanism to reduce conflicts between managers and shareholders over the deployment of corporate resources and the riskiness of the firm (Jensen and Meckling, 1976; Shleifer and Vishny, 1997). Public and academic interest in chief executive officer (CEO) compensation in the banking industry has increased exponentially in the aftermath of the financial crisis of 2007–2008. While this is partly motivated by public outrage over the levels of CEO remuneration in an industry that has become increasingly reliant on public funds, the view that the structure of executive pay has given rise to socially harmful risk-taking by banks is gaining ground. Thus, the use of incentive pay in banking is widely believed to have motivated excessive risk-taking and to have acted as a contributory factor to the recent financial crisis (e.g., Bebchuk and Spamann, 2009; IMF, 2010; Federal Reserve Bank, 2010). Understanding the relationship between CEO pay and bank risk-taking matters. It matters because of the importance of banks to any monetary economy, and because taking risks is a key component of many of the activities performed by banks. Furthermore, optimally designed incentive compensation is essential to induce managerial effort by incentivizing bank CEOs to commit to risky but positive net present value (NPV) projects (Jensen and Meckling, 1976; Amihud and Lev, 1981; Smith and Stulz, 1985). Finally, understanding the pay–risk relationship also matters because CEO pay at banks has become subject to increasing levels of...
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