Incentivizing Calculated Risk-Taking: Evidence from an Experiment with Commercial Bank Loan Officers

69 Pages Posted: 6 Jul 2012

See all articles by Shawn Allen Cole

Shawn Allen Cole

Harvard Business School

Martin Kanz

World Bank; World Bank - Development Research Group (DECRG)

Leora F. Klapper

World Bank; World Bank - Development Research Group (DECRG)

Multiple version iconThere are 4 versions of this paper

Date Written: July 5, 2012

Abstract

This paper uses a series of experiments with commercial bank loan officers to test the effect of performance incentives on risk-assessment and lending decisions. We first show that, while high-powered incentives lead to greater screening effort and more profitable lending, their power is muted by both deferred compensation and the limited liability typically enjoyed by credit officers. Second, we present direct evidence that incentive contracts distort judgment and beliefs, even among trained professionals with many years of experience. Loans evaluated under more permissive incentive schemes are rated significantly less risky than the same loans evaluated under pay-for-performance.

Keywords: loan officer incentives, banking, emerging markets

JEL Classification: D03, G21 J22, J33, L2

Suggested Citation

Cole, Shawn Allen and Kanz, Martin and Klapper, Leora F., Incentivizing Calculated Risk-Taking: Evidence from an Experiment with Commercial Bank Loan Officers (July 5, 2012). Harvard Business School Finance Working Paper No. 13-001. Available at SSRN: https://ssrn.com/abstract=2101648 or http://dx.doi.org/10.2139/ssrn.2101648

Shawn Allen Cole (Contact Author)

Harvard Business School ( email )

Soldiers Field Road
Morgan 270C
Boston, MA 02163
United States

Martin Kanz

World Bank ( email )

1818 H Street, NW
Washington, DC 20433
United States

World Bank - Development Research Group (DECRG)

1818 H. Street, N.W.
MSN3-311
Washington, DC 20433
United States

Leora F. Klapper

World Bank ( email )

1818 H Street, N.W.
Washington, DC 20433
United States
202-473-8738 (Phone)

HOME PAGE: http://econ.worldbank.org/staff/lklapper

World Bank - Development Research Group (DECRG)

1818 H. Street, N.W.
MSN3-311
Washington, DC 20433
United States

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