Bank Bonuses and Bail-Outs
40 Pages Posted: 2 Mar 2013
Date Written: February 2013
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