Bank Bonuses and Bail-Outs

Hakenes, Hendrik; Schnabel, Isabel

doi:10.2139/ssrn.2226360

Bank Bonuses and Bail-Outs

MPI Collective Goods Preprint, No. 2013/03

40 Pages Posted: 2 Mar 2013

See all articles by Hendrik Hakenes

Hendrik Hakenes

Finance Group; Centre for Economic Policy Research (CEPR)

Isabel Schnabel

University of Bonn - Institute for Financial Economics and Statistics; Max Planck Society for the Advancement of the Sciences - Max Planck Institute for Research on Collective Goods

There are 2 versions of this paper

Date Written: February 2013

Abstract

This paper shows that bonus contracts may arise endogenously as a response to agency problems within banks, and analyzes how compensation schemes change in reaction to anticipated bail-outs. If there is a risk-shifting problem, bail-out expectations lead to steeper bonus schemes and even more risk-taking. If there is an effort problem, the compensation scheme becomes flatter and effort decreases. If both types of agency problems are present, a sufficiently large increase in bailout perceptions makes it optimal for a welfare-maximizing regulator to impose caps on bank bonuses. In contrast, raising managers’ liability can be counterproductive.

Keywords: bonus payments, bank bail-outs, bank management compensation, risk-shifting, underinvestment, limited and unlimited liability

JEL Classification: J33, G21, G28, M52

Suggested Citation: Suggested Citation

Hakenes, Hendrik and Schnabel, Isabel, Bank Bonuses and Bail-Outs (February 2013). MPI Collective Goods Preprint, No. 2013/03. Available at SSRN: https://ssrn.com/abstract=2226360 or http://dx.doi.org/10.2139/ssrn.2226360