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The External Effects of Bank Executive Pay: Liquidity Creation and Systemic Risk

62 Pages Posted: 25 Mar 2016 Last revised: 21 Sep 2016

Robert DeYoung

University of Kansas School of Business

Minjie Huang

University of Louisville - Department of Finance

Date Written: September 15, 2016

Abstract

We develop a conceptual framework that links executive compensation incentives to the external risks and returns generated by the firm but borne by society. Recent advances in measuring liquidity creation (Berger and Bouwman, 2009) and systemic risk (Acharya, et al. forthcoming) allow us to estimate our framework for U.S. commercial banking companies. We find that CEO pay-performance incentives reduce both positive liquidity creation externalities and negative systemic risk externalities, while pay-risk incentives increase both externalities. Our findings infer a tradeoff for bank regulators: Restrictions on executive pay aimed at reducing systemic risk likely necessitate a reduction in system-wide liquidity creation.

Keywords: executive compensation, systemic risk, liquidity creation, spillovers

JEL Classification: G21, G28, J33

Suggested Citation

DeYoung, Robert and Huang, Minjie, The External Effects of Bank Executive Pay: Liquidity Creation and Systemic Risk (September 15, 2016). Available at SSRN: https://ssrn.com/abstract=2753759

Robert DeYoung

University of Kansas School of Business ( email )

Summerfield Hall
1300 Sunnyside Avenue
Lawrence, KS 66045
United States
785-864-1806 (Phone)

Minjie Huang (Contact Author)

University of Louisville - Department of Finance ( email )

College of Business
Harry Frazier Hall
Louisville, KY 40292
United States

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