Executive compensation in banks: insights from CEO equity incentives and securitization transactions
- 179 Downloads
This paper investigates whether CEO equity incentives promote risk-taking activities in the financial industry. Prior research shows that, during the recent credit crisis, banks whose CEOs had high equity incentives performed significantly worse than banks whose CEOs had low equity incentives. A possible explanation for this result is that the incentive to boost stock price induced CEOs to take risks that turned out to be extremely costly. Focusing on securitization transactions that were among the fundamental causes of the financial crisis and using a sample of US financial institutions, the paper provides evidence that banks whose CEOs had high equity incentives engaged in securitization transactions to a greater extent than did financial institutions guided by CEOs with low equity incentives. Moreover, the paper shows that CEOs with high equity incentives securitized riskier loans than did CEOs with low incentives. This study helps to clarify the role of equity-based compensation in promoting risk-taking behaviors in banks.
KeywordsExecutive compensation CEO incentives Securitization Financial crisis Banking industry
I would like to thank Antonio Parbonetti for his guidance on previous versions of this paper. I acknowledge helpful comments and suggestions from Pietro Bonetti, Paul Laux, Gilad Livne, Garen Markarian, Pietro Mazzola, Krishnagopal Menon, Giovanna Michelon, Stephen Penman, Stephen Ryan, Marco Trombetta, and the seminar partecipants at WHU Otto Beisheim School of Management, University of Padova, City University London, 36th European Accounting Association Annual Congress.
- Amiram, D., Landsman, W. R., Peasnell, K. V., & Shakespeare, C. (2011). Market reaction to securitization retained interest impairments during the financial crisis of 2007–2008: Are implicit guarantees worth the paper they’re not written on? SSRN Working Paper. Available at https://ssrn.com/abstract=1508664.
- Balachandran, S., Kogut, B. & Harnal, H. (2010). Did executive compensation encourage excessive risk-taking in financial institutions? Working paper, Columbia University. Available at https://www8.gsb.columbia.edu.
- Bank for International Settlements (2011). Report on asset securitization incentives. Basel Committee on Banking Supervision. Available at http://www.bis.org/publ/joint26.pdf.
- Bebchuk, L. (2012). Executive pay and the financial crisis. The World Bank. Available at http://blogs.worldbank.org/allaboutfinance/executive-pay-and-the-financial-crisis.
- Bebchuk, L. A., Cohen, A., & Spamann, H. (2010). The wages of failure: Executive compensation at Bear Stearns and Lehman 2000–2008. Yale Journal on Regulation, 27, 257–282.Google Scholar
- Brewer, E., Hunter, W. C., & Jackson, W. E. (2004). Investment opportunity set, product mix, and the relationship between bank CEO compensation and risk-taking. Working paper, Federal Reserve Bank of Atlanta. Available at https://ssrn.com/abstract=665243.
- Browning, L. (2007). Accounting said to hide lender losses. The New York Times. Published 2007-05-01.Google Scholar
- Core, J. E., Guay, W., & Larcker, D. F. (2003). Executive equity compensation and incentives: A survey. Economic Policy Review, 9(1), 27–50.Google Scholar
- Diamond, D.W., & Rajan, R. (2009). The credit crisis: Conjectures about causes and remedies. NBER Working Paper No. 14739. Available at http://www.nber.org/papers/w14739.pdf.
- Jiangli, W., & Pritsker, M. (2008). The impact of securitization on US bank holding companies. SSRN Working paper. Available at https://ssrn.com/abstract=1102284.
- Kolasinski, A. C., & Yang, N. (2017). Managerial myopia and the mortgage meltdown. SSRN Working paper. Available at SSRN: https://ssrn.com/abstract=2815013.
- Merton, R. C. (1974). On the pricing of corporate debt: The risk structure of interest rates. Journal of Finance, 29(2), 449–470.Google Scholar