Regulation, Subordinated Debt, and Incentive Features of CEO Compensation in the Banking Industry

42 Pages Posted: 26 Nov 2007

See all articles by Kose John

Kose John

New York University (NYU) - Department of Finance

Yiming Qian

University of Connecticut

Hamid Mehran

Independent

Date Written: November 2007

Abstract

We study CEO compensation in the banking industry by considering banks' unique claim structure in the presence of two types of agency problems: the standard managerial agency problem and the risk-shifting problem between shareholders and debt holders. We empirically test two hypotheses derived from this framework: that the pay-for-performance sensitivity of bank CEO compensation (1) decreases with the total leverage ratio and (2) increases with the intensity of monitoring provided by regulators and non-depository (subordinated) debt holders. We construct an index of the intensity of outsider monitoring based on four variables: the subordinated debt ratio, subordinated debt rating, nonperforming loan ratio, and BOPEC rating (regulators' assessment of a bank's overall health and financial condition). We find supporting evidence for both hypotheses. Our results hold after controlling for the endogeneity among compensation, leverage, and monitoring; they are robust to various regression specifications and sample criteria.

Keywords: banking, regulation, subordinated debt, CEO compensation, pay-for-performance sensitivity, risk shifting

JEL Classification: G21, G34, J33

Suggested Citation

John, Kose and Qian, Yiming and Mehran, Hamid, Regulation, Subordinated Debt, and Incentive Features of CEO Compensation in the Banking Industry (November 2007). FRB of New York Staff Report No. 308. Available at SSRN: https://ssrn.com/abstract=1032616 or http://dx.doi.org/10.2139/ssrn.1032616

Kose John

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
212-998-0337 (Phone)
212-995-4233 (Fax)

Yiming Qian

University of Connecticut ( email )

2100 Hillside Road U-1041F, Room 452
Storrs, CT 06269
United States
860-486-2774 (Phone)

Hamid Mehran (Contact Author)

Independent ( email )

No Address Available

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