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Theory and Stylised Facts of Bank CEO Pay Consequences

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Bank CEOs

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Abstract

If bank CEOs are special, as each bank is, do the characteristics of banks influence the ways that CEOs make complex and non-routine strategic decisions? Do CEOs leave their mark or have a personal style when making investment, financing and other strategic decisions? Moreover, given the incentives for risk-taking implicit in CEO remuneration contracts, how do these incentives interact with unobservable CEO characteristics? In this Chapter, we review the major theoretical and empirical findings of the literature, highlighting how different CEO characteristics (personal and acquired) contribute to performance and risk-taking. We present empirical evidence of the sensitivity of CEO pay to bank performance and risk in pre-crisis years, and the role it played in causing the recent financial crisis. We discuss contrasting findings, highlighting the debated relationship between pre-crisis CEO incentives to take risks and crisis-period bank performance. We then discuss the main regulatory interventions undertaken in response to this issue, and their suitability in light of recent banking CEO compensation models. We conclude this chapter with a description of CEO incentives in relation to strategic decisions, such as mergers and acquisitions and restructuring programs, and how these may influence bank performance and risk.

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Notes

  1. 1.

    There is much empirical literature on CEO characteristics and the performance of nonfinancial firms (e.g., Adams et al. 2005; Custódio and Metzger 2013; Custódio et al. 2013; Kaplan et al. 2012).

  2. 2.

    This effect is also economically meaningful, with a one standard deviation in MBA education resulting in improved performance by 11.4% relative to the mean.

  3. 3.

    See Malmendier and Tate (2008) and Gervais et al. (2011).

  4. 4.

    See Guiso et al. (2006) and Fernández and Fogli (2009).

  5. 5.

    This evidence was found for the sensitivity of both total compensation and stock option grants to bank performance.

  6. 6.

    Recent regulatory proposals in the USA also contain requirements to defer compensation (OCC, Board, FDIC, FHFA, NCUA, and SEC, 2016, §7). Compensation regulation proposals that do not require deferred compensation instead rely on forward-looking risk measures, such as CDS spreads, to reduce risk shifting.

  7. 7.

    Ferrarini (2015) discusses recent international rules concerning the mandatory structure of managerial compensation in banks. He questions the idea that managerial compensation has led banks to take excessive risks during the financial crisis and suggests an improvement in capital adequacy and organisational requirements rather than a direct intervention in bankers’ incentives.

  8. 8.

    A different strand of the literature focuses on the inefficiencies that arise in the labour market for bank CEOs (Thanassoulis 2012; Bannier et al. 2013; Archarya et al. 2016). In these models, labour market imperfections lead to risk-taking incentives that are excessive from the bank’s perspective, which provides a rationale for regulation.

  9. 9.

    Sundaram and Yermack (2007) and Gerakos (2010) empirically tested Jensen and Meckling (1976) insight on CEOs of non-financial firms.

  10. 10.

    Vega measures the change in CEO wealth associated with a 1% change in a bank’s stock return volatility. This measure is also labelled the ‘risk-sensitivity of compensation’.

  11. 11.

    See Ciscel and Carroll (1980) and Agarwal (1981), among others.

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  1. Faculty of Economics and Management, Free University of Bozen-Bolzano, Bolzano, Italy

    Claudia Curi & Maurizio Murgia

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  1. Claudia Curi
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Curi, C., Murgia, M. (2018). Theory and Stylised Facts of Bank CEO Pay Consequences. In: Bank CEOs. SpringerBriefs in Finance. Springer, Cham. https://doi.org/10.1007/978-3-319-90866-3_3

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