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 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


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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