Bonus Caps, Deferrals and Bankers' Risk-Taking
70 Pages Posted: 2 Mar 2016
Date Written: July 1, 2018
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
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