Bank Executive Compensation and Capital Requirements Reform

81 Pages Posted: 9 Mar 2011 Last revised: 22 May 2013

Sanjai Bhagat

University of Colorado at Boulder - Department of Finance

Brian J. Bolton

Portland State University - School of Business Administration

Date Written: May 2013

Abstract

We study the executive compensation structure in the largest 14 U.S. financial institutions during 2000-2008. Our results are mostly consistent with and supportive of the findings of Bebchuk, Cohen and Spamann (2010), that is, managerial incentives matter – incentives generated by executive compensation programs led to excessive risk-taking by banks leading to the current financial crisis. Also, our results are generally not supportive of the conclusions of Fahlenbrach and Stulz (2011) that the poor performance of banks during the crisis was the result of unforeseen risk.

We recommend the following compensation structure for senior bank executives: Executive incentive compensation should only consist of restricted stock and restricted stock options – restricted in the sense that the executive cannot sell the shares or exercise the options for two to four years after their last day in office.

The above equity based incentive programs lose their effectiveness in motivating managers to enhance shareholder value as a bank’s equity value approaches zero (as they did for the too-big-to-fail banks in 2008). Hence, for equity based incentive structures to be effective, banks should be financed with considerable more equity than they are being financed currently.

Keywords: Executive Compensation, Bank Capital, Bank Capital Reform

JEL Classification: G21, G32, G34

Suggested Citation

Bhagat, Sanjai and Bolton, Brian J., Bank Executive Compensation and Capital Requirements Reform (May 2013). Available at SSRN: https://ssrn.com/abstract=1781318 or http://dx.doi.org/10.2139/ssrn.1781318

Sanjai Bhagat (Contact Author)

University of Colorado at Boulder - Department of Finance ( email )

Campus Box 419
Boulder, CO 80309
United States
303-492-7821 (Phone)

Brian J. Bolton

Portland State University - School of Business Administration ( email )

Portland, OR 97207-0751
United States

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