Optimal Regulation, Executive Compensation and Risk Taking by Financial Institutions

54 Pages Posted: 7 Mar 2015 Last revised: 19 Nov 2016

Jens Hilscher

University of California, Davis

Yoram Landskroner

Hebrew University of Jerusalem - Department of Finance and Banking; New York University (NYU) - Leonard N. Stern School of Business

Alon Raviv

Bar-Ilan University - Graduate School of Business Administration

Date Written: November 18, 2016

Abstract

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

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

Jens Hilscher

University of California, Davis ( email )

One Shields Avenue
Davis, CA 95616
United States

Yoram Landskroner

Hebrew University of Jerusalem - Department of Finance and Banking ( email )

Mount Scopus
Jerusalem, 91905
Israel

New York University (NYU) - Leonard N. Stern School of Business ( email )

44 West 4th Street
New York, NY NY 10012
United States

Alon Raviv (Contact Author)

Bar-Ilan University - Graduate School of Business Administration ( email )

The Graduate School of Business Administration
Ana and Max Web st
Ramat Gan
Israel

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