Research Handbook on International Banking and Governance
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Research Handbook on International Banking and Governance

Edited by James R. Barth, Chen Lin and Clas Wihlborg

The contributors – top international scholars from finance, law and business – explore the role of governance, both internal and external, in explaining risk-taking and other aspects of the behavior of financial institutions. Additionally, they discuss market and policy features affecting objectives and quality of governance. The chapters provide in-depth analysis of factors such as: ownership, efficiency and stability; market discipline; compensation and performance; social responsibility; and governance in non-bank financial institutions. Only through this kind of rigorous examination can one hope to implement the financial reforms necessary and sufficient to reduce the likelihood and severity of future crises.
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Chapter 8: Executive Compensation and Risk-taking in European Banking

Rym Ayadi, Emrah Arbak and Willem Pieter De Groen


Rym Ayadi, Emrah Arbak and Willem Pieter De Groen 8.1 INTRODUCTION The financial crisis of 2007–2008 has revealed serious weaknesses in the corporate governance of major financial institutions and has led to severe public criticism of the role that executive compensation packages played in encouraging excessive risk-taking and myopic behaviour in the financial sector. Although the remuneration schemes were not seen as the main cause of the financial crisis of 2007–2008, they were a major contributing factor. Indeed, the existing pay packages tend to provide bank executives with myopic incentives, such as bonuses that are either fully at the discretion of the management board or related to a narrow and shortterm definition of company performance.1 Such incentives lead to a race to inflate profits and, in most cases, excessive risk-taking. In response to this concern, the European Commission announced in the Communication of 4 March 2009 for the Spring European Council on driving European recovery2 that it would: (i) as a matter of urgency, address the impropriety of the remuneration framework in the financial sector with a view to curbing excessive risk-taking and short-termism, and (ii) as a second step, examine more broadly and report on current corporate governance practices in financial institutions, making recommendations including for legislative initiatives, where appropriate. Immediately after the G20 London Summit, the Commission issued two recommendations in April 2009, one strengthening its 2004 Recommendation on remuneration of directors of listed companies and the second one addressing remuneration of risk-taking staff in the...

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