Bonus Caps, Deferrals and Bankers' Risk-Taking

70 Pages Posted: 2 Mar 2016

See all articles by Esa Jokivuolle

Esa Jokivuolle

Bank of Finland, Research Unit

Jussi Keppo

National University of Singapore - NUS Business School

Xuchuan Yuan

Harbin Institute of Technology - School of Management

Date Written: July 1, 2018

Abstract

We derive a principal-agent model to analyze the effectiveness of bonus caps and deferrals in regulating banks' risk-taking. We calibrate the model to a sample of large US banks on the eve of the Global Financial Crisis and run counterfactual analyses of the potential effects of the regulations. We find that the risk-reduction effect on the median bank is negligible as banks respond to the regulations by increasing the earnings sensitivity of bonuses. However, on a small number of banks with high bonus to salary ratios prior to 2008, the bonus cap has a sizeable risk-reduction effect. In contrast, bonus deferrals have only negligible effects on all sample banks.

Keywords: banking, bonuses, regulation, compensation, Dodd–Frank Act

JEL Classification: G01, G21, G28, J33, M52

Suggested Citation

Jokivuolle, Esa and Keppo, Jussi and Yuan, Xuchuan, Bonus Caps, Deferrals and Bankers' Risk-Taking (July 1, 2018). Bank of Finland Research Discussion Paper No. 5/2015. Available at SSRN: https://ssrn.com/abstract=2740982

Esa Jokivuolle (Contact Author)

Bank of Finland, Research Unit ( email )

P.O. Box 160
FIN-00101 Helsinki
Finland
+358 10 831 2309 (Phone)

HOME PAGE: http://www.bof.fi/en/suomen_pankki/organisaatio/asiantuntijoita/jokivuolle_esa/

Jussi Keppo

National University of Singapore - NUS Business School ( email )

1 Business Link
Singapore, 117592
Singapore

Xuchuan Yuan

Harbin Institute of Technology - School of Management ( email )

Heilongjiang
China

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