Regulation of Bank Management Compensation

Since passage of the Economic Stabilization Act of 2008, the government has been explicitly and implicitly regulating the compensation of top managers at a number of U.S. banks. In addition, bank regulators have added evaluations of bank management compensation packages to the list of factors taken into account in supervisory safety-and-soundness examinations, and pending legislation would require the Federal Reserve to establish explicit standards for evaluating the risk implications of bankers’ pay. Furthermore, the Federal Deposit Insurance Corporation has proposed incorporating the structure of bank management compensation into the determination of banks’ deposit insurance premiums. This policy brief surveys the academic literature on the empirical relationship between bank management compensation and risk, discusses theoretical considerations that may underlie the mixed evidence regarding this relationship, and assesses potential pitfalls associated with actual and proposed regulations of the structure of management compensation in the banking industry. The main conclusion is that there is neither persuasive empirical evidence nor an unambiguous theoretical argument in favor of either direct or indirect regulation of bankers’ pay.