Investment Horizon, Risk, and Compensation in the Banking Industry
Posted: 12 Jul 2013
Date Written: June 2013
This paper examines the relation between the investment horizon of banks and their CEO compensation, and its consequences for risk and performance. We find that banks with short-term investment intensity pay more cash bonus, exhibit higher risk and perform more poorly than banks with longer-term investment intensity. This evidence is broadly consistent with the view that short-term means of compensation encouraged a short-term investment focus, which in turn led to both higher risk and resulted in poorer performance, culminating in the sub-prime crisis. The inverse risk-performance relation suggests pay schemes were incongruent with shareholders’ interest. Moreover, pay arrangements used in banks prior to the subprime crisis exposed banks to the ex-post settling up problem (the clawback problem).
Keywords: Investment horizon, Compensation, Risk, Performance, Claw-back
JEL Classification: M41, M43, G20, J33
Suggested Citation: Suggested Citation