Retention Requirements and Incentives for Controlling Inefficient Risk-Taking -- Bridging Banking, Securitization and Capital Requirements

15 Pages Posted: 22 Nov 2014

See all articles by Rose Neng Lai

Rose Neng Lai

University of Macau

Robert A. Van Order

George Washington University

Date Written: November 20, 2014

Abstract

This paper models incentives for risk-taking by managers of banks or securitization deals. Of particular interest are risk-retention rules for producers of structured securitization deals, which have been mandated by the Dodd-Frank Act; the model can also be applied to bank managers. We show how incentives can be set up so that problems of asymmetric information can co-exist with socially optimal risk-taking. The role of holding an equity piece as an incentive tool has been over-emphasized; the best “skin in the game” incentive structure for management is to hold securities of all levels of risk, including the safest piece. As a device for protecting against bank runs, the best incentive tools require tilting the incentive structure toward the safest pieces, but not by much.

Keywords: Financial Institutions, Contingent Convertible Bonds, Management Incentives, Risk-Taking, Dodd-Frank Act

JEL Classification: G2

Suggested Citation

Lai, Rose Neng and Van Order, Robert A., Retention Requirements and Incentives for Controlling Inefficient Risk-Taking -- Bridging Banking, Securitization and Capital Requirements (November 20, 2014). Available at SSRN: https://ssrn.com/abstract=2528579 or http://dx.doi.org/10.2139/ssrn.2528579

Rose Neng Lai (Contact Author)

University of Macau ( email )

Av. Da Universidade, Taipa
Macau, Nil
Macau

Robert A. Van Order

George Washington University ( email )

2121 I Street NW
Washington, DC 20052
United States

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
61
Abstract Views
393
rank
377,561
PlumX Metrics