Executive Compensation and Risk Taking

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

See all articles by Patrick Bolton

Patrick Bolton

Imperial College London; 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

Imperial College London ( email )

South Kensington Campus
Exhibition Road
London, Greater London SW7 2AZ
United Kingdom

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

European Corporate Governance Institute (ECGI)

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

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

Joel D. Shapiro

University of Oxford - Said Business School ( email )

Park End Street
Oxford, OX1 1HP
Great Britain

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