Approach and Structure of Part 4 Has a Risk-Taking Focus

Chapter 11 introduces Part 4 of the Key Code and Advanced Handbook relating to issues in executive compensation and accountability including incentives, bonuses, equity and option compensation and the BEAR. We begin with an introduction to variable performance-based pay and risk-taking including remuneration committee considerations and a discussion of shareholder value-maximisation, bank risk-taking and bank failures. Section 11.1 contains an introduction to incentives, option-based and equity-based pay and risk-taking by banks including, ‘core’ components of remuneration, aims for examining studies on variable compensation and bank risk-taking, economic justification for equity compensation – ‘buyout’ not ‘reward’ – and the ‘wall street bonus system’ which may be countered by equity compensation. The chapter then reviews compensation governance variables from Stage 1 followed by an examination of variable performance-based pay and deposit insurance which increase moral hazard and risk-taking. We find variable option compensation in combination with limited liability increases risk-taking as does variable pay combined with short-term profit results and reporting. There is then a summary of studies and new governance variables for variable performance-based compensation and bank risk-taking including variable compensation, deposit insurance and government bailout. There follows a new governance variable for compensation in combination with limited liability which increases risk-taking as does the new governance variable for pay in combination with short-term profit results and reporting. In these new bank-specific governance variables for compensation, we find that risk-taking in excess of risk appetite increases the likelihood of bank failure.