Executive Compensation and Risk Taking in European Banking

Abstract

Recent financial crisis has renewed attention on compensation schemes and their impact on risk-taking in depository institutions. Without ample theoretical and empirical backing, the recent policy proposals in the EU have suggested that long-term incentive plans that are closely linked to bank performance would lead to less risk-taking. Using a novel database on executive pay for 53 systemically important banks in the EU for the years 1999-2009, our analysis shows, instead, that the presence of the so-called “long-term incentive plans” may actually augment risk-taking. Moreover, although their values depend closely on long-term market performance, the presence of an option plan does not seem to lead to more risk. Our results are robust to the consideration of the joint determination of compensation and risk as well as alternative risk measures.

Keywords: Risk-taking, banking industry, executive compensation, stock options, financial crisis

JEL Classification: G12, G21, J33