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Performance compensation contracts and CEOs’ incentive to shift risk to debtholders: An empirical analysis

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  • George Benston
  • Jocelyn Evan

Abstract

The paper investigates the relationships among CEO incentive contracts, manager ownership, charter value, and bank risk taking. We analyze whether the presence and magnitude of incentive contracts induce CEOs of financially distressed firms and firms with high manager ownership to take unprofitable risks that shift wealth from debtholders to equity holders. Our sample focuses on banks that had both the incentive and opportunity to shift risks, and compares them with those that did not. We compare weak and strong banks in periods when the banks’ principal creditor, the FDIC, was a lenient and then a stringent monitor. The evidence is consistent with bonus compensation inducing CEOs of financially weak firms to shift risk to debtholders only if they do not have large insider ownership. The evidence is also consistent with these contracts rewarding CEOs for their effort to manage unforeseeable risk albeit not their ability. Low charter value banks with high managerial ownership took profitable risk during the lenient regulatory period. Copyright Academy of Economics and Finance 2006

Suggested Citation

  • George Benston & Jocelyn Evan, 2006. "Performance compensation contracts and CEOs’ incentive to shift risk to debtholders: An empirical analysis," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 30(1), pages 70-92, March.
  • Handle: RePEc:spr:jecfin:v:30:y:2006:i:1:p:70-92
    DOI: 10.1007/BF02834276
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    Cited by:

    1. Hsin-Hui Chiu & Eva Wagner, 2020. "CEO Bonus Pay and Firm Credit Risk," International Journal of Risk and Contingency Management (IJRCM), IGI Global, vol. 9(1), pages 1-19, January.
    2. Chen, Minghua & Jeon, Bang Nam & Wang, Rui & Wu, Ji, 2015. "Corruption and bank risk-taking: Evidence from emerging economies," Emerging Markets Review, Elsevier, vol. 24(C), pages 122-148.
    3. Jens Hagendorff & Francesco Vallascas, 2012. "CEO Pay and Risk-taking in Banking: The Roles of Bonus Plans and Deferred Compensation in Curbing Bank Risk-taking," Chapters, in: James R. Barth & Chen Lin & Clas Wihlborg (ed.), Research Handbook on International Banking and Governance, chapter 9, Edward Elgar Publishing.

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