Bank Bonuses and Bail-Outs
University of Hannover; Max Planck Institute for Research on Collective Goods
University of Mainz - Faculty of Law and Economics; Max Planck Society for the Advancement of the Sciences - Max Planck Institute for Research on Collective Goods
CEPR Discussion Paper No. DP8852
This paper shows that bonus contracts may arise endogenously as a response to agency problems within banks, and analyzes how compensation schemes change in reaction to anticipated bail-outs. If there is a risk-shifting problem, bail-out expectations lead to steeper bonus schemes and even more risk-taking. If there is an effort problem, the compensation scheme becomes flatter and effort decreases. If both types of agency problems are present, a sufficiently large increase in bail-out perceptions makes it optimal for a welfare-maximizing regulator to impose caps on bank bonuses. In contrast, raising managers liability is counterproductive.
Number of Pages in PDF File: 38
Keywords: bank bail-outs, bank management compensation, bonus payments, limited and unlimited liability, risk-shifting, underinvestment
JEL Classification: G21, G28, J33, M52working papers series
Date posted: March 1, 2012
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