Incentive Pay and Systemic Risk

48 Pages Posted: 20 Nov 2016 Last revised: 29 Aug 2018

Rui A. Albuquerque

Boston College, Carroll School of Management; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Luis M. B. Cabral

New York University (NYU) - Leonard N. Stern School of Business - Department of Economics; Centre for Economic Policy Research (CEPR)

José Correia Guedes

Catholic University of Portugal (UCP) - Faculty of Economic Science and Business Studies

Multiple version iconThere are 3 versions of this paper

Date Written: August 21, 2018

Abstract

We show that, in the presence of correlated investment opportunities across firms, risk sharing between firm shareholders and firm managers leads to compensation contracts that include relative performance evaluation. These contracts bias investment choices towards correlated investment opportunities, thus creating systemic risk. Furthermore, we show that leverage amplifies all such effects. In the context of the banking industry, we analyze recent policy recommendations regarding firm managerial pay and show how shareholders optimally undo the policies' intended effects.

Keywords: Systemic risk, bank regulation, relative performance evaluation, optimal contracts

JEL Classification: G01, G21, G28

Suggested Citation

Albuquerque, Rui A. and Cabral, Luis M. B. and Correia Guedes, José, Incentive Pay and Systemic Risk (August 21, 2018). European Corporate Governance Institute (ECGI) - Finance Working Paper No. 490/2016. Available at SSRN: https://ssrn.com/abstract=2872935 or http://dx.doi.org/10.2139/ssrn.2872935

Rui A. Albuquerque (Contact Author)

Boston College, Carroll School of Management ( email )

140 Commonwealth Avenue
Chestnut Hill, MA 02467-3808
United States

HOME PAGE: http://ruialbuquerque.webs.com

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI) ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Luis M. B. Cabral

New York University (NYU) - Leonard N. Stern School of Business - Department of Economics ( email )

269 Mercer Street
New York, NY 10003
United States
212-998-0858 (Phone)
212-998-4218 (Fax)

HOME PAGE: http://www.stern.nyu.edu/~lcabral

Centre for Economic Policy Research (CEPR)

London
United Kingdom

José Filipe Correia Guedes

Catholic University of Portugal (UCP) - Faculty of Economic Science and Business Studies ( email )

Lisboa, 1600
Portugal

Register to save articles to
your library

Register

Paper statistics

Downloads
288
rank
78,101
Abstract Views
855
PlumX