Designing Bankers' Pay: Using Contingent Capital to Reduce Risk-shifting Incentives

25 Pages Posted: 9 Mar 2021 Last revised: 28 May 2021

See all articles by Jens Hilscher

Jens Hilscher

University of California, Davis

Sharon Peleg Lazar

Tel Aviv University

Alon Raviv

Bar-Ilan University - Graduate School of Business Administration

Date Written: April 13, 2021

Abstract

Including contingent convertible bonds (coco) in the capital structure of a bank affects the sensitivity to risk of its equity-based compensation. Such risk-shifting incentives can be reduced if the coco bonds are well-designed. Similarly, we show that compensating executives instead with well-designed coco bonds can also reduce risk-shifting incentives. In practice, however, most coco bonds have characteristics that result in both stock and coco compensation having large sensitivities to changes in asset risk -- equity-based compensation encourages executives to increase risk, coco compensation to reduce risk. We show that a pay package combining both stock and coco can practically eliminate risk-shifting incentives and that it can be implemented with a bank's preexisting coco bonds.

Keywords: contingent capital, executive compensation, risk-shifting, banking regulation, coco compensation

JEL Classification: G13, G21, G28, E58

Suggested Citation

Hilscher, Jens and Peleg Lazar, Sharon and Raviv, Alon, Designing Bankers' Pay: Using Contingent Capital to Reduce Risk-shifting Incentives (April 13, 2021). Available at SSRN: https://ssrn.com/abstract=3799187 or http://dx.doi.org/10.2139/ssrn.3799187

Jens Hilscher

University of California, Davis ( email )

One Shields Avenue
Apt 153
Davis, CA 95616
United States

Sharon Peleg Lazar

Tel Aviv University ( email )

Tel Aviv
Israel

Alon Raviv (Contact Author)

Bar-Ilan University - Graduate School of Business Administration ( email )

The Graduate School of Business Administration
Ana and Max Web st
Ramat Gan
Israel

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