Competition, Bonuses, and Risk-Taking in the Banking Industry

48 Pages Posted: 9 Oct 2010 Last revised: 30 Sep 2011

Christina E. Bannier

Justus-Liebig-University Giessen

Eberhard Feess

Frankfurt School of Finance & Management gemeinnützige GmbH

Natalie Packham

Berlin School of Economics and Law

Date Written: September 28, 2011

Abstract

Remuneration systems in the banking industry, particularly bonus payments, have frequently been blamed for contributing to the build-up of risks leading to the recent financial crisis. In our model banks compete for managerial talent that is private information. Competition for talent sets incentives to offer bonuses inducing risk-taking that is excessive not only from society's perspective, but also from the viewpoint of the banks themselves. In fact, bonus payments and excessive risk-taking are increasing with competition. Thus, our model offers a rationale why bonuses are paid even when reducing the expected profits of banks. This confirms the impact of competitive pressures on the remuneration schemes as claimed by many industry representatives and assigns a positive role to legal restrictions on bonus payments.

Keywords: Bonuses, excessive risk, screening, competition

JEL Classification: D86, J31, J33

Suggested Citation

Bannier, Christina E. and Feess, Eberhard and Packham, Natalie, Competition, Bonuses, and Risk-Taking in the Banking Industry (September 28, 2011). Available at SSRN: https://ssrn.com/abstract=1688835 or http://dx.doi.org/10.2139/ssrn.1688835

Christina E. Bannier (Contact Author)

Justus-Liebig-University Giessen ( email )

Licher Str. 62
Gießen, 35394
Germany
+49 641 99 22551 (Phone)

Eberhard Feess

Frankfurt School of Finance & Management gemeinnützige GmbH ( email )

Sonnemannstraße 9-11
Frankfurt am Main, 60314
Germany

Natalie Packham

Berlin School of Economics and Law ( email )

Badensche Strasse 50-51
Berlin, D-10825
Germany

HOME PAGE: http://www.packham.net

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