Bank CEO Incentives and the Credit Crisis

Abstract:     
We investigate whether bank performance during the credit crisis of 2008 is related to CEO incentives and share ownership before the crisis and whether CEOs reduced their equity stakes in their banks in anticipation of the crisis. There is no evidence that banks with CEOs whose incentives were better aligned with the interests of their shareholders performed better during the crisis and evidence that these banks actually performed worse both in terms of stock returns and in terms of accounting return on equity (ROE). Further, banks with higher option compensation and with a larger fraction of compensation given in the form of cash bonuses did not have worse performance during the crisis. All these results hold for banks that received TARP assistance as well as other banks that did not. The incentives of non-CEO top executives are unrelated to bank performance during the crisis. Bank CEOs did not reduce their holdings of shares in anticipation of the crisis or during the crisis; there is also no evidence that they hedged their equity exposure. Consequently, they suffered extremely large wealth losses as a result of the crisis.

Keywords: Financial crisis, CEO compensation, insider trading

JEL Classifications: G01, G21, G32

Working Paper Series