Government Distortions, Bankers’ Pay and Excessive Risk
نویسندگان
چکیده
If debt markets can price the risk of projects accurately, then the interests of shareholders and the regulator diverge. Shareholders see their value maximised by an equity-rewarded executive. However we demonstrate that such executives destroy welfare by selecting excessively risky projects due to two types of government-induced distortions: the debt tax shield and the implicit too-big-to-fail government guarantee. We analyse the compensation regulations open to the regulator, and assess how a bank can game the intervention. Rewarding in debt and deferred equity-based pay cannot serve the regulator by reducing excessive risk taking. Mandatory clawbacks can reduce excessive risk taking but are vulnerable to gaming via options and deferred pay. Rebasing RoE metrics can also serve the regulator and are robust to options and deferred pay based on EBIT, but not deferred equity. Bonus caps only serve the regulator if executives wish to maximise social welfare when indifferent. Provisional Draft – Please do not circulate without authors’ permission.
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