54 Pages Posted: 7 Mar 2015 Last revised: 19 Nov 2016
Date Written: November 18, 2016
We present an equilibrium model of financial institutions in which we examine the optimal regulation of risk taking. Choice of risk levels result from strategic interactions of regulators, shareholders, and management. Regulators use caps on asset risk and equity-based compensation to achieve the optimal level of risk; shareholders choose levels of management's stock ownership; and management chooses asset risk. We characterize the socially optimal level of risk. If there is perfect information and enforcement, using one policy tool is sufficient. If enforcement is limited or information is asymmetric, there can be gains to social welfare from employing both policy tools.
Keywords: regulation; financial institutions; executive compensation; risk taking; financial crises
JEL Classification: G18, G21, G28
Suggested Citation: Suggested Citation
Hilscher, Jens and Landskroner, Yoram and Raviv, Alon, Optimal Regulation, Executive Compensation and Risk Taking by Financial Institutions (November 18, 2016). Available at SSRN: https://ssrn.com/abstract=2574404 or http://dx.doi.org/10.2139/ssrn.2574404