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Is Capping Executive Bonuses Useful?

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  • Kentaro Asai

Abstract

This paper develops a theoretical framework to study the impact of bonus caps on banks’ risk taking. In the model, labor market price adjustments can offset the direct effects of bonus caps. The calibrated model suggests that bonus caps are only effective when bank executives’ mobility is restricted. It also suggests, irrespective of the degree of labor market mobility, bonus caps simultaneously reduce risk shifting by bank executives (too much risk taking because of limited liability), but aggravate underinvestment (bank executives foregoing risky but productive projects). Hence, the welfare effects of bonus caps critically depend on initial conditions, including the relative importance of risk shifting versus underinvestment.

Suggested Citation

  • Kentaro Asai, 2016. "Is Capping Executive Bonuses Useful?," IMF Working Papers 2016/196, International Monetary Fund.
    • Handle: RePEc:imf:imfwpa:2016/196
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    References listed on IDEAS

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    1. Fabienne Llense, 2010. "French CEOs' Compensations: What is the Cost of a Mandatory Upper Limit?," CESifo Economic Studies, CESifo Group, vol. 56(2), pages 165-191, June.
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    5. Kevin J. Murphy, 2013. "Regulating Banking Bonuses in the European Union: a Case Study in Unintended Consequences," European Financial Management, European Financial Management Association, vol. 19(4), pages 631-657, September.
    6. Boyd, John H. & Hakenes, Hendrik, 2014. "Looting and risk shifting in banking crises," Journal of Economic Theory, Elsevier, vol. 149(C), pages 43-64.
    7. Fabienne Llense, 2010. "French CEOs' Compensations: What is the Cost of a Mandatory Upper Limit?," Post-Print hal-00497583, HAL.
    8. Chen, Carl R. & Steiner, Thomas L. & Whyte, Ann Marie, 2006. "Does stock option-based executive compensation induce risk-taking? An analysis of the banking industry," Journal of Banking & Finance, Elsevier, vol. 30(3), pages 915-945, March.
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    Cited by:

    1. Rui Albuquerque & Luís Cabral & José Guedes, 2019. "Incentive Pay and Systemic Risk," The Review of Financial Studies, Society for Financial Studies, vol. 32(11), pages 4304-4342.
    2. Felix Bolduan & Ivo Schedlinsky & Friedrich Sommer, 2021. "The influence of compensation interdependence on risk-taking: the role of mutual monitoring," Journal of Business Economics, Springer, vol. 91(8), pages 1125-1148, October.
    3. Harris, Qun & Tanaka, Misa & Soane, Emma, 2020. "Does bonus cap curb risk taking? An experimental study of relative performance pay and bonus regulation," Bank of England working papers 882, Bank of England.

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