The Economics of Deferral and Clawback Requirements
57 Pages Posted: 5 Oct 2021 Last revised: 19 Oct 2021
Date Written: October 3, 2021
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: financial regulation, moral hazard, compensation design, clawbacks, bonus deferral, short-termism
JEL Classification: D86, G28
Suggested Citation: Suggested Citation