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

49 Pages Posted: 25 Mar 2016 Last revised: 14 Oct 2021

See all articles by Robert DeYoung

Robert DeYoung

University of Kansas School of Business

Minjie Huang

University of Louisville - Department of Finance

Date Written: June 7, 2021

Abstract

We develop a conceptual framework that links the compensation incentives of bank executives to the risk and return externalities generated by banks but borne by society. Using 1994 to 2016 data from large U.S. commercial banks, we find that CEO pay-performance incentives reduce both negative systemic risk externalities and positive liquidity creation externalities, while pay-risk incentives increase both externalities. Our findings offer support for Federal Reserve guidelines that encourage greater reliance on long-term equity-based compensation, and they infer a regulatory tradeoff: Bank executive pay rules aimed at reducing systemic risk will result in reduced system-wide liquidity creation as well.

Keywords: Executive pay incentives, externalities, liquidity creation, systemic risk

JEL Classification: G21, G28, J33

Suggested Citation

DeYoung, Robert and Huang, Minjie, The External Effects of Bank Executive Pay: Liquidity Creation and Systemic Risk (June 7, 2021). Journal of Financial Intermediation, Volume 47, July 2021, 100920, Available at SSRN: https://ssrn.com/abstract=2753759 or http://dx.doi.org/10.2139/ssrn.2753759

Robert DeYoung

University of Kansas School of Business ( email )

Capitol Federal Hall
1654 Naismith Drive
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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