On the Economics of Crisis Contracts

48 Pages Posted: 16 May 2016

See all articles by Elias Aptus

Elias Aptus

ETH Zürich - CER-ETH - Center of Economic Research at ETH Zurich

Volker Britz

ETH Zürich - CER-ETH - Center of Economic Research at ETH Zurich

Hans Gersbach

ETH Zurich - CER-ETH -Center of Economic Research; IZA Institute of Labor Economics; CESifo (Center for Economic Studies and Ifo Institute); Centre for Economic Policy Research (CEPR)

Date Written: May 2016

Abstract

We examine the impact of so-called "Crisis Contracts" on bank managers' risk-taking incentives and on the probability of banking crises. Under a Crisis Contract, managers are required to contribute a pre-specified share of their past earnings to finance public rescue funds when a crisis occurs. This can be viewed as a retroactive tax that is levied only when a crisis occurs and that leads to a form of collective liability for bank managers. We develop a game-theoretic model of a banking sector whose shareholders have limited liability, so that society at large will suffer losses if a crisis occurs. Without Crisis Contracts, the managers' and shareholders' interests are aligned, and managers take more than the socially optimal level of risk. We investigate how the introduction of Crisis Contracts changes the equilibrium level of risk-taking and the remuneration of bank managers. We establish conditions under which the introduction of Crisis Contracts will reduce the probability of a banking crisis and improve social welfare. We explore how Crisis Contracts and capital requirements can supplement each other and we show that the efficacy of Crisis Contracts is not undermined by attempts to hedge.

JEL Classification: C79, G21, G28

Suggested Citation

Aptus, Elias and Britz, Volker and Gersbach, Hans, On the Economics of Crisis Contracts (May 2016). CEPR Discussion Paper No. DP11267, Available at SSRN: https://ssrn.com/abstract=2780375

Elias Aptus

ETH Zürich - CER-ETH - Center of Economic Research at ETH Zurich ( email )

Zürichbergstrasse 18
Zurich, 8092
Switzerland

Volker Britz (Contact Author)

ETH Zürich - CER-ETH - Center of Economic Research at ETH Zurich ( email )

Zürichbergstrasse 18
Zurich, 8092
Switzerland

Hans Gersbach

ETH Zurich - CER-ETH -Center of Economic Research ( email )

Zürichbergstrasse 18
Zurich, 8092
Switzerland
+41 44 632 82 80 (Phone)
+41 44 632 18 30 (Fax)

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
0
Abstract Views
506
PlumX Metrics