The External Effects of Bank Executive Pay: Liquidity Creation and Systemic Risk
62 Pages Posted: 25 Mar 2016 Last revised: 21 Sep 2016
Date Written: September 15, 2016
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: Suggested Citation