The Dark Side of Bank CEO Risk-taking Incentives: Evidence from Bank Lending Decisions

Abstract

This paper investigates how bank CEO risk-taking incentives influence bank lending decisions. Consistent with the existing CEO incentive literature, we find that CEOs with higher risk-taking incentives (vega) tend to relax their lending standards in bank loan contracts to pursue higher compensation. We find that banks with a high vega tend to charge a significantly lower loan spread, demand fewer loan covenants, and have lower probability to seek collateral. Results become weaker when banks have strong corporate governance mechanisms, supporting the proposition that high CEO risk-taking incentives may create an agency problem between a bank manager and shareholders.

Keywords: CEO incentives, bank loan contracts, corporate governance, agency problem

JEL Classification: G21, G32, G34