Bonus Caps, Deferrals and Bankers' Risk-Taking
75 Pages Posted: 1 Oct 2019
Date Written: June 17, 2016
We derive a principal-agent model to analyze the eﬀectiveness of bonus caps and deferrals in regulating banks’ risk-taking. We calibrate the model to a sample of large US banks on the eve of the Global Financial Crisis and run counterfactual analyses of the potential eﬀects of the regulations. We ﬁnd that the risk-reduction eﬀect on the median bank is negligible as banks respond to the regulations by increasing the earnings sensitivity of bonuses. However, on a small number of banks with high bonus to salary ratios prior to 2008, the bonus cap has a sizeable risk reduction eﬀect. In contrast, bonus deferrals have only negligible eﬀects on all sample banks.
Keywords: banking, bonuses, regulation, compensation, Dodd-Frank Act
JEL Classification: G01, G21, G28, J33, M52
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