The Structure of Banker's Pay

Fisher College of Business Working Paper No. 2016-03-12

Charles A. Dice Center Working Paper No. 2016-12

43 Pages Posted: 15 Jun 2016 Last revised: 23 Aug 2016

See all articles by Benjamin Bennett

Benjamin Bennett

Tulane University - A.B. Freeman School of Business

Radhakrishnan Gopalan

Washington University in St. Louis - John M. Olin Business School

Anjan V. Thakor

Washington University, Saint Louis - John M. Olin School of Business; European Corporate Governance Institute (ECGI)

Date Written: August 20, 2016

Abstract

While executive compensation is often blamed for the excessive risk taking by banks, little is known about the operating performance incentives used in the finance industry both prior to and subsequent to the recent crisis. We provide a comprehensive analysis of incentive design -- the link of compensation to operating performance -- in financial firms and compare incentive structures in financial firms to those in non-financial firms. Top executives in financial firms are paid less than their counterparts in non-financial firms of similar size and performance. Banks (and insurance firms) link a larger fraction of top executive pay to short-term accounting metrics like ROE and EPS and a smaller fraction to (long-term) stock price. Performance targets for bankers are not related to the risk of the bank, and ROE targets are not appropriately adjusted for leverage. Consequently, the design of executive compensation in banking may encourage both high leverage and risk-taking, and our evidence provides a potential explanation for the strong positive correlation that we document between the extent of short-term pay for bank CEOs and the risk of the bank before the financial crisis.

Keywords: Executive compensation, corporate governance, finance industry, TARP

JEL Classification: F34, G32, G33, G38, K42

Suggested Citation

Bennett, Benjamin and Gopalan, Radhakrishnan and Thakor, Anjan V., The Structure of Banker's Pay (August 20, 2016). Fisher College of Business Working Paper No. 2016-03-12, Charles A. Dice Center Working Paper No. 2016-12, Available at SSRN: https://ssrn.com/abstract=2795260 or http://dx.doi.org/10.2139/ssrn.2795260

Benjamin Bennett (Contact Author)

Tulane University - A.B. Freeman School of Business ( email )

7 McAlister Drive
New Orleans, LA 70118
United States

HOME PAGE: https://sites.google.com/site/benjaminbennettfinance/home

Radhakrishnan Gopalan

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

Anjan V. Thakor

Washington University, Saint Louis - John M. Olin School of Business ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

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