Bonus Caps, Deferrals and Bankers&Apos; Risk-Taking

75 Pages Posted: 2 Mar 2016 Last revised: 10 Jul 2018

See all articles by Esa Jokivuolle

Esa Jokivuolle

Bank of Finland, Research Unit

Jussi Keppo

National University of Singapore - NUS Business School

Xuchuan Yuan

affiliation not provided to SSRN

Date Written: March 3, 2015

Abstract

Regulators restrict bankers’ risk-taking by bonus caps or deferrals. We derive a structural model to analyze these compensation regulations and show that for a risk-neutral banker subject to positive switching costs of reducing bank risk, a bonus deferral is impotent while a sufficiently tight bonus cap reduces risk-taking. The model suggests that a bonus cap that equals fixed salary (as in the EU) reduces risk on average by 13% under conservatively calibrated positive switching costs. Further, the bonus cap would have considerably reduced risk-taking incentives in most US banks that did poorly during the global financial crisis. We also show that the bonus deferral is effective if the banker is risk-averse and the switching costs are not too high.

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

Suggested Citation

Jokivuolle, Esa and Keppo, Jussi and Yuan, Xuchuan, Bonus Caps, Deferrals and Bankers&Apos; Risk-Taking (March 3, 2015). 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

affiliation not provided to SSRN

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