Regulation, Subordinated Debt, and Incentive Features of CEO Compensation in the Banking Industry
42 Pages Posted: 26 Nov 2007
Date Written: November 2007
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: Suggested Citation