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Relative Performance, Banker Compensation, and Systemic Risk

47 Pages Posted: 20 Nov 2016 Last revised: 25 May 2017

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: May 23, 2017

Abstract

We show that, in the presence of correlated investment opportunities across banks, risk sharing between bank shareholders and bank managers leads to (a) compensation contracts that include relative performance evaluation; and (b) investment decisions that are biased toward such correlated opportunities, thus creating systemic risk. We analyze various policy recommendations regarding bank managerial pay and show how shareholders optimally undo the policies' intended risk-reducing effects. We discuss alternative measures that can effectively decrease the systemic risk arising from pay packages.

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, Relative Performance, Banker Compensation, and Systemic Risk (May 23, 2017). 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 Albuquerque (Contact Author)

Boston College, Carroll School of Management ( email )

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

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

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

European Corporate Governance Institute (ECGI) ( email )

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

Luis 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)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

José Correia Guedes

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

Lisboa, 1600
Portugal

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