Bank Capital Requirements and Mandatory Deferral of Compensation

30 Pages Posted: 24 Jul 2014

See all articles by Eberhard Feess

Eberhard Feess

Frankfurt School of Finance & Management gemeinnützige GmbH

Ansgar Wohlschlegel

Portsmouth Business School

Date Written: July 23, 2014

Abstract

Tighter capital requirements and mandatory deferral of compensation are among the most prominently advocated regulatory measures to reduce excessive risk-taking in the banking industry. We analyze the interplay of the two instruments in an economy with two heterogenous banks that can fund uncorrelated projects with fully diversifiable risk or correlated projects with systemic risk. If both project types are in abundant supply, we find that full mandatory deferral of compensation is beneficial as it allows for weaker capital requirements, and hence for a larger banking sector, without increasing the incentives for risk-shifting. With competition for uncorrelated projects, however, deferred compensation may misallocate correlated projects to the bank which is inferior in managing risks. Our findings challenge the current tendency to impose stricter regulations on more sophisticated institutes.

Keywords: Bank capital requirements, deferred bonuses, risk-shifting, financial crisis, executive compensation.

JEL Classification: J33, G21, G28, D62.

Suggested Citation

Feess, Eberhard and Wohlschlegel, Ansgar, Bank Capital Requirements and Mandatory Deferral of Compensation (July 23, 2014). Available at SSRN: https://ssrn.com/abstract=2470444 or http://dx.doi.org/10.2139/ssrn.2470444

Eberhard Feess

Frankfurt School of Finance & Management gemeinnützige GmbH ( email )

Adickesallee 32-34
Frankfurt am Main, 60322
Germany

Ansgar Wohlschlegel (Contact Author)

Portsmouth Business School ( email )

Portsmouth, PO1 3DE
United Kingdom

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