A Theory of Bank Regulation and Management Compensation
Posted: 6 Mar 2001
We show that concentrating bank regulation on bank capital ratios may be ineffective in controlling risk-taking. We propose, instead, a more direct mechanism of influencing bank risk-taking incentives, in which the FDIC insurance premium scheme incorporates incentive features of top-management compensation. With this scheme, we show that bank owners choose an optimal management compensation structure that induces first-best value-maximizing investment choices by a bank's management. We explicitly characterize the parameters of the optimal management compensation structure and the fairly priced FDIC insurance premium, in the presence of a single or multiple sources of agency problems.
Keywords: Bank regulation, Capital regulation, FDIC insurance, Management compensation, Agency problems
JEL Classification: G21, G28, G34, J33
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