Incentive Compensation in the Banking Industry: Insights from Economic Theory

Federal Reserve Bank of Minneapolis Economic Policy Paper 09-01

Posted: 13 Apr 2010

See all articles by Christopher Phelan

Christopher Phelan

Federal Reserve Bank of Minneapolis

Douglas Clement

affiliation not provided to SSRN

Date Written: December 1, 2010

Abstract

How can banks and similar institutions design optimal compensation systems? Would such systems conflict with the goals of society? This paper considers a theoretical framework of how banks structure job contracts with their employees to explore three points: the structure of a socially optimal compensation system; the structure of a compensation system that is privately optimal, given the reality of government-guaranteed bank debt; and policy interventions that can lead from the second structure to the first. Analysis reveals a potential policy option: providing proper incentives to banks by charging debt default insurance premiums that depend on the compensation structure banks choose. If policymakers consider this unwise or impractical, then it may be useful for government to regulate bank compensation more directly.

Suggested Citation

Phelan, Christopher J. and Clement, Douglas, Incentive Compensation in the Banking Industry: Insights from Economic Theory (December 1, 2010). Federal Reserve Bank of Minneapolis Economic Policy Paper 09-01. Available at SSRN: https://ssrn.com/abstract=1586484

Christopher J. Phelan (Contact Author)

Federal Reserve Bank of Minneapolis ( email )

90 Hennepin Avenue
Minneapolis, MN 55480
United States
612-204-5615 (Phone)

HOME PAGE: http://phelan.mpls.frb.fed.us

Douglas Clement

affiliation not provided to SSRN ( email )

Register to save articles to
your library

Register

Paper statistics

Abstract Views
831
PlumX Metrics