The Economics of Deferral and Clawback Requirements
57 Pages Posted: 28 Jul 2020 Last revised: 16 Aug 2020
Date Written: July 2020
We analyze the effects of regulatory interference in compensation contracts, focusing on recent mandatory deferral and clawback requirements restricting (incentive) compensation of material risk-takers in the financial sector. Moderate deferral requirements have a robustly positive effect on equilibrium risk-management effort only if the bank manager's outside option is sufficiently high, else, their effectiveness depends on the dynamics of information arrival. Stringent deferral requirements unambiguously backfire. We characterize when regulators should not impose any deferral regulation at all, when it can achieve second-best welfare, when additional clawback requirements are of value, and highlight the interaction with capital regulation.
Keywords: bonus deferral, clawbacks, compensation regulation, moral hazard, principal-agent models with externalities, Short-termism
JEL Classification: D86, G21, G28
Suggested Citation: Suggested Citation