Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/212313 
Year of Publication: 
2015
Series/Report no.: 
Bank of Finland Research Discussion Papers No. 5/2015
Publisher: 
Bank of Finland, Helsinki
Abstract: 
Regulators restrict bankers' risk-taking by bonus caps or deferrals. We derive a structural model to analyze these compensation regulations and show that for a risk-neutral banker subject to positive switching costs of reducing bank risk, a bonus deferral is impotent while a sufficiently tight bonus cap reduces risk-taking. The model suggests that a bonus cap that equals fixed salary (as in the EU) reduces risk on average by 13% under conservatively calibrated positive switching costs. Further, the bonus cap would have considerably reduced risk-taking incentives in most US banks that did poorly during the global financial crisis. We also show that the bonus deferral is effective if the banker is risk-averse and the switching costs are not too high.
JEL: 
G01
G21
G28
J33
M52
Persistent Identifier of the first edition: 
ISBN: 
978-952-323-029-3
Document Type: 
Working Paper

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