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Risk Taking Incentives and the Great Financial Crisis

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  • Jean-Pierre Danthine

    (CEPR - Center for Economic Policy Research, UNIL - Université de Lausanne = University of Lausanne, PJSE - Paris Jourdan Sciences Economiques - UP1 - Université Paris 1 Panthéon-Sorbonne - ENS-PSL - École normale supérieure - Paris - PSL - Université Paris Sciences et Lettres - INRA - Institut National de la Recherche Agronomique - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique, PSE - Paris School of Economics - UP1 - Université Paris 1 Panthéon-Sorbonne - ENS-PSL - École normale supérieure - Paris - PSL - Université Paris Sciences et Lettres - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement)

Abstract

High leverage distorts the purpose of limited liability. Limited liability is a design feature intended to promote risk taking. It is not appropriate in situations where decision-makers are prone to socially excessive risk taking. While much progress has been made to correct risk taking incentives in banking under Basel 3, not enough has been done to address the toxic cocktail resulting from combining high leverage with limited liability. Deferred compensation schemes should be generalized and bonus payments in the form of high trigger Cocos should be promoted.

Suggested Citation

  • Jean-Pierre Danthine, 2017. "Risk Taking Incentives and the Great Financial Crisis ," PSE Working Papers halshs-01571627, HAL.
    • Handle: RePEc:hal:psewpa:halshs-01571627
    Note: View the original document on HAL open archive server: https://shs.hal.science/halshs-01571627
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    Keywords

    risk taking; financial crisis;

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