Incentivizing Calculated Risk-Taking: Evidence from an Experiment with Commercial Bank Loan Officers

Cole, Shawn Allen; Kanz, Martin; Klapper, Leora F.

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Incentivizing Calculated Risk-Taking: Evidence from an Experiment with Commercial Bank Loan Officers

Journal of Finance, Forthcoming

53 Pages Posted: 6 Apr 2014

See all articles by Shawn Allen Cole

Martin Kanz

World Bank; World Bank - Development Research Group (DECRG)

Leora F. Klapper

World Bank; World Bank - Development Research Group (DECRG)

There are 4 versions of this paper

Date Written: March 15, 2014

Abstract

We conduct an experiment with commercial bank loan officers to test how performance compensation affects risk-assessment and lending. High-powered incentives lead to greater screening effort and more profitable lending decisions. This effect is, however, muted by deferred compensation and limited liability, two standard features of loan officer compensation contracts. We find that career concerns and personality traits affect loan officer behavior, but show that the response to incentives does not vary with traits such as risk-aversion, optimism or overconfidence. Finally, we present evidence that incentive contracts distort the assessment of credit risk, even among trained professionals with many years of experience.

Keywords: Loan officer incentives, banking, emerging markets

JEL Classification: D03, G21, J22, J33, L2

Suggested Citation: Suggested Citation

Cole, Shawn Allen and Kanz, Martin and Klapper, Leora F., Incentivizing Calculated Risk-Taking: Evidence from an Experiment with Commercial Bank Loan Officers (March 15, 2014). Journal of Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2420470