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Outside Monitoring and CEO Compensation in the Banking IndustryKose JohnNew York University (NYU) - Department of Finance Yiming QianUniversity of Iowa - Department of Finance Hamid MehranFederal Reserve Bank of New York December 2009 Journal of Corporate Finance, Forthcoming Abstract: We hypothesize that CEO compensation is optimally designed to trade off two types of agency problems: the standard shareholder-management agency problem as well as the risk-shifting problem between shareholders and debtholders. Analyses in this setup produces two predictions: (1) the pay-for-performance sensitivity of CEO compensation decreases with the leverage ratio; and (2) the pay-for-performance sensitivity of CEO compensation increases with the intensity of outside monitoring on the firm’s risk choice. We test these two hypotheses for the banking industry where regulators and nondepository (subordinated) debtholders provide outside monitoring on the risk choice. We construct an index of the intensity of outside monitoring based on three variables: subordinated debt rating, non performing loan ratio and examination rating assigned by regulators. We find supporting evidence for both hypotheses.
Number of Pages in PDF File: 44 Keywords: corporate governance, CEO compensation, pay-for-performance sensitivity, risk-shifting, agency problems, banking, regulation, subordinated debt JEL Classification: G21, G34, J33 Accepted Paper SeriesDate posted: February 10, 2004 ; Last revised: January 12, 2010Suggested CitationContact Information
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