Regulating Bank CEO Compensation and Active Boards

We analyze the role of using CEO compensation and capital requirements in bank regulation. With a passive uninformed board that delegates the choice of bank strategy to the CEO, requiring a compensation contract where the CEO receives a fixed fraction of total bank payoff eliminates the risk shifting problem and can implement first best; no additional regulatory limit on bank leverage is needed. With an informed, active board that represents shareholder interests, however, there exists no CEO compensation that assures that the socially optimal level of risk is chosen. The optimal policy mix consists of deferred compensation for the CEO, a bonus cap or a compensation that is linear in total payoff, and a constraint on bank leverage. Regulating CEO compensation allows to relax regulatory capital requirements.

Keywords: Bank regulation, CEO compensation, bank strategy, risk shifting, board intervention

JEL Classification: G21, G28

Suggested Citation: Suggested Citation

Kolm, Julian and Laux, Christian and Loranth, Gyongyi, Regulating Bank CEO Compensation and Active Boards (August 2016). Forthcoming in the Review of Finance, Available at SSRN: https://ssrn.com/abstract=2453124 or http://dx.doi.org/10.2139/ssrn.2453124