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Incentive-Based Capital Requirements

31 Pages Posted: 3 Dec 2011 Last revised: 20 May 2016

Christian Eufinger

IESE Business School

Andrej Gill

Goethe University Frankfurt - Faculty of Economics and Business Administration

Date Written: May 2016

Abstract

This paper proposes a new regulatory approach that implements capital requirements contingent on executive incentive schemes. We argue that excessive risk-taking in the financial sector originates from the shareholder moral hazard created by government guarantees rather than from corporate governance failures within banks. The idea behind the proposed regulatory approach is thus that the more the compensation structure decouples the interests of bank managers from those of shareholders by curbing risk-taking incentives, the higher the leverage the bank is permitted to take on. Consequently, the risk-shifting incentives caused by government guarantees and the risk-mitigating incentives created by the compensation structure offset each other such that the manager chooses the socially efficient investment policy.

Keywords: Basel III, capital regulation, compensation, leverage, risk

JEL Classification: G21, G28, G30, G32, G38

Suggested Citation

Eufinger, Christian and Gill, Andrej, Incentive-Based Capital Requirements (May 2016). Available at SSRN: https://ssrn.com/abstract=1967492 or http://dx.doi.org/10.2139/ssrn.1967492

Christian Eufinger (Contact Author)

IESE Business School ( email )

Avinguda de Pearson, 21
Barcelona, 08034
Spain

Andrej Gill

Goethe University Frankfurt - Faculty of Economics and Business Administration ( email )

Grüneburgplatz 1
Frankfurt am Main, D-60323
Germany

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