We test if bonus and stock compensation of bank executives prior to the financial
crisis contributed to the formation of systemic risk during the crisis. For
92 U.S. banks, neither higher cash bonus shares nor equity stakes of CEOs contribute
to systemic capital shortfall (SCS, Acharya et al., 2010; Brownlees and
Engle, 2011). Higher bonuses for non-CEO board members prior to the crisis,
in turn, increased systemic risk taking during the crisis significantly. Deferred
earnings and stock option compensation of non-CEOs a reduced systemic risk.
These results suggest that the classical solution of agency problems of providing
managers with long-term incentives may work as well to mitigate negative
externalities born out by systemic importance. However, the results emphasize
the detrimental effects of short-termism inherent in unconditional cash incentives
and the importance to consider non-CEO executives in potential future
regulation of bank manager compensation.
(Coauthor Jakob J. Bosma)