Who Benefits from Bank Trading Activity: Shareholders or Employees?

Abstract

The global financial crisis triggered a political debate about bank bonuses and their impact on risk-taking. We investigate whether excessive levels of trading activity have adverse effects for bank shareholders, and the impact of variable compensation on outcomes. We find that excessive trading activity is positively correlated with bank risk, negatively correlated with bank profitability and buy-and-hold returns, both during and after the subprime crisis. We find banks with excessive trading activity underperforms a portfolio of banks with little or no trading activity. This underperformance is greatest for banks where employee compensation represents a higher share of trading profits.

Keywords: Bank holding companies, trading activity, risk-taking, stock performance, compensation, financial crisis

JEL Classification: G1, G21, G32