Bank CEOs by Claudia Curi & Maurizio Murgia

Author:Claudia Curi & Maurizio Murgia
Language: eng
Format: epub
Publisher: Springer International Publishing, Cham

3.2 CEO Compensation, Risk-Taking and Performance

Compensation practices in the banking industry are widely believed to induce excessive risk-taking and, thus, to have played an important role in causing the recent financial crisis (e.g., Bebchuk and Spamann 2010; IMF 2010; Board of Governors et al. 2010). The question of whether compensation policies are structured to promote risk-taking in order to maximise the value of the put option feature of fixed-rate deposit insurance has attracted considerable interest from bank regulators and academics. One of the early studies on CEO compensation in the banking industry is that of Houston and James (1995). They found that compensation policies in banking are not designed to promote excessive risk-taking. However, they showed that, compared with CEOs in other industries, CEOs in US banks, on average, receive less cash compensation, hold fewer stock options, and receive a smaller percentage of their total compensation in the form of options and stocks (over the period 1980–1990). Differences in the compensation structures of banks and non-banks, as well as within the banking industry generally, can be explained by the nature of the firm’s set of assets and investment opportunities, which has a profound influence on the type of agency problems that a particular firm faces. Their results provide support to the ‘contracting hypothesis’. Adams and Mehran (2003) confirmed this trend for a sample of US bank over the period 1986–1996. They stated that, in the last few years, the use of stock options in banking executive compensation packages has increased. Although this pattern has followed the pattern of other industries, the growth and level of stock options remain significantly lower in banks than in manufacturing firms. Similarly, other studies show a significant difference in the levels and structures of executive compensation between banks and non-financial companies, both in the US and abroad (Becher et al. 2005; Gregg et al. 2012). The pronounced reliance on long-term compensation for the highest-paid employees indicates that employee retention matters (Oyer 2004), as long-term compensation emerges in optimal contracts to lengthen employees’ view on their tenure at the current employer (Holmstrom and Joan Ricart 1986; Giannetti 2011). Moreover, theories that stress the importance of competition for talent (e.g., Gabaix and Landier 2008; Terviö 2008) have recently been supported by Giannetti and Metzger (2015). They examine a sample of 531 individuals located in 23 countries between 1996 and 2012. They confirm that a positive correlation exists between the level of pay and the amount of long-term compensation offered in the financial industry, not only for CEOs, but also for non-executive employees below top management (another profession characterised by high competition for talent). In financial centres, this evidence appears stronger, indicating that retention motives are important drivers of the level and structure of compensation offered to high-talent employees.

An important channel through which we observe an increase of sensitivity of CEO compensation to bank performance is through changes in the regulatory environment. In a principal-agent framework, firms may alter the structure of the incentive contracts they offer to

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