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An experimental study of the effects of negative, capped and deferred bonuses on risk taking in a multi-period setting

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Abstract

As a response to the financial crisis in 2008, the European bank authorities have adopted new rules for managerial remuneration. These rules are intended to mitigate managerial propensity to excessive risk taking. The purpose of this paper is to examine three prominent recommendations in these remuneration rules: the use of negative bonuses, the use of bonus caps and the use of deferred bonus payment. The paper advances the theory that cognitive frames created by compensation design affect risk-taking behaviour. We conduct a two-by-two within-subject experiment in which 153 students are set an investment task involving two periods. We find higher risk taking with the high variance bonus scheme that contains a negative bonus option. While bonus deferral appears to have no such initial effect on risk taking, it affects risk behaviour in the second period as a response to positive and negative outcomes from the first period. The findings contribute to the theory and practice of bonus system design and the application of contemporary remuneration recommendations in the financial sector.

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Notes

  1. Our assumption is realistic, as there is little evidence that bonus caps actually lead to overall pay reductions. Reduction in bonus potential is compensated for through increased fixed pay (EBA 2013; Guardian 2013).

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Acknowledgments

The authors would like to thank Joshua Ronen, Willie Choi, two anonymous reviewers, and the participants of the conferences Accounting & Regulation (Siena 2010), Mid-term AAA, Management Accounting Section (Atlanta 2011) and EAA (Rome 2011) for their suggestions and comments on earlier versions of this paper. We gratefully acknowledge the financial support from the Faculty of Economics at the University of Ljubljana, provided within the framework of the research project on “The position of firms, financial institutions and government in adapting to the common European economic environment”.

Author information

Authors and Affiliations

  1. RSM Erasmus University, Burgemeester Oudlaan 50, 3062 PA, Rotterdam, The Netherlands

    Frank Hartmann

  2. Faculty of Economics, University of Ljubljana, Kardeljeva pl. 17, 1000, Ljubljana, Slovenia

    Sergeja Slapničar

Authors
  1. Frank Hartmann
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  2. Sergeja Slapničar
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Correspondence to Sergeja Slapničar.

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Appendix

Appendix

1.1 Control variable

Personal risk preference was measured as a tolerance for ambiguity (MacDonald (1970)).

For each of the following questions, respondents were asked to indicate their level of agreement with the statements on a five-point Likert scale (1 = completely disagree, 2 = I disagree, 3 = neutral, 4 = I agree 5 = completely agree). TFA score was calculated as an average of all items.

I’m just a little uncomfortable with people unless I feel that I can understand their behaviour

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There is a right way and a wrong way to do almost everything

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I get pretty anxious when I am in a social situation over which I have no control

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It bothers me when I am unable to follow another person’s train of thought

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I have always felt that there is a clear difference between right and wrong

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It bothers me when I do not know how other people react to me

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If I were a doctor, I would prefer the uncertainties of a psychiatrist to the clear and definite work of a surgeon. (Reverse)

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Vague and impressionistic pictures really have little appeal for me

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If I were a scientist, it would bother me that my work would never be completed because science will always make new discoveries

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Before an examination, I feel much less anxious if I know how many questions there will be

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Sometimes I rather enjoy going against the rules and doing things I am not supposed to do. (Reverse)

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I do not like to work on a problem unless there is a possibility of coming out with a clear-cut and unambiguous answer

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I like to fool around with new ideas, even if they turn out later to be a total waste of time. (Reverse)

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Hartmann, F., Slapničar, S. An experimental study of the effects of negative, capped and deferred bonuses on risk taking in a multi-period setting. J Manag Gov 19, 875–896 (2015). https://doi.org/10.1007/s10997-014-9297-6

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  • DOI: https://doi.org/10.1007/s10997-014-9297-6

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