A Theory of Bank Regulation and Management Compensation

42 Pages Posted: 11 Nov 2008

See all articles by Kose John

Kose John

New York University (NYU) - Department of Finance

Anthony Saunders

New York University - Leonard N. Stern School of Business

Lemma W. Senbet

University of Maryland - Robert H. Smith School of Business

Multiple version iconThere are 4 versions of this paper

Date Written: September 1996

Abstract

This paper examines the incentive structure underlying the current features of bank regulation, particularly the role of prompt corrective action, capital requirements and mandatory restrictions on asset choice as primary tools to control risk-shifting incentives of depository institutions. We show that capital regulation has limited effectiveness, given the observed high leverage ratios of banks. We propose instead a more direct and effective mechanism of influencing incentives through the role of top-management compensation, whereby a fair and revenue-neutral FDIC premium incorporates incentive features of top-management compensation as well as the level of bank capitalization. With this pricing scheme (for FDIC insurance) we show that bank owners choose an optimal management compensation structure which induces first-best value-maximizing investment choices by a bank s management. We also characterize the parameters of the optimal managerial compensation structure and the FDIC premium schedule explicitly.

Suggested Citation

John, Kose and Saunders, Anthony and Senbet, Lemma W., A Theory of Bank Regulation and Management Compensation (September 1996). NYU Working Paper No. FIN-96-030. Available at SSRN: https://ssrn.com/abstract=1297745

Kose John (Contact Author)

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)

Anthony Saunders

New York University - Leonard N. Stern School of Business ( email )

44 West 4th Street
9-190, MEC
New York, NY 10012-1126
United States
212-998-0711 (Phone)
212-995-4220 (Fax)

Lemma W. Senbet

University of Maryland - Robert H. Smith School of Business ( email )

College Park, MD 20742-1815
United States
301-405-2242 (Phone)
301-405-0359 (Fax)

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