47 Pages Posted: 20 Nov 2016 Last revised: 21 Mar 2017
Date Written: November 20, 2016
This paper shows that in the presence of correlated investment opportunities across banks, risk sharing between bank shareholders and bank managers leads to compensation contracts that include relative performance evaluation and to investment decisions that are biased toward such correlated opportunities, thus creating systemic risk. We analyze various policy recommendations regarding bank managerial pay and show that shareholders optimally undo the intended risk-reducing effects of the policies, demonstrating their ineffectiveness in curbing systemic risk.
Keywords: Systemic risk, bank regulation, relative performance evaluation, optimal contracts
JEL Classification: G01, G21, G28
Suggested Citation: Suggested Citation
Albuquerque, Rui A. and Cabral, Luis M. B. and Correia Guedes, José, Relative Performance, Banker Compensation, and Systemic Risk (November 20, 2016). European Corporate Governance Institute (ECGI) - Finance Working Paper No. 400/2017. Available at SSRN: https://ssrn.com/abstract=2872935 or http://dx.doi.org/10.2139/ssrn.2872935