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Executive Compensation and Risk Taking

44 Pages Posted: 7 Jul 2010 Last revised: 14 Nov 2011

Patrick Bolton

Columbia Business School - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

Hamid Mehran

Independent

Joel D. Shapiro

University of Oxford - Said Business School

Date Written: November 3, 2011

Abstract

This paper studies the connection between risk taking and executive compensation in financial institutions. A theoretical model of shareholders, debtholders, depositors, and an executive suggests that 1) in principle, excessive risk taking (in the form of risk shifting) may be addressed by basing compensation on both stock price and the price of debt (proxied by the credit default swap spread), but 2) shareholders may be unable to commit to designing compensation contracts in this way and indeed may not want to because of distortions introduced by either deposit insurance or naive debtholders. The paper then provides an empirical analysis that suggests that debt-like compensation for executives is believed by the market to reduce risk for financial institutions.

Keywords: executive compensation, risk taking

JEL Classification: G21, G34

Suggested Citation

Bolton, Patrick and Mehran, Hamid and Shapiro, Joel D., Executive Compensation and Risk Taking (November 3, 2011). FRB of New York Staff Report No. 456. Available at SSRN: https://ssrn.com/abstract=1635349 or http://dx.doi.org/10.2139/ssrn.1635349

Patrick Bolton

Columbia Business School - Department of Economics ( email )

420 West 118th Street
New York, NY 10027
United States

HOME PAGE: http://www0.gsb.columbia.edu/faculty/pbolton/

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

Hamid Mehran (Contact Author)

Independent ( email )

No Address Available

Joel Shapiro

University of Oxford - Said Business School ( email )

Park End Street
Oxford, OX1 1HP
Great Britain

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