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Is Capping Executive Bonuses Useful?
Author:
Kentaro Asai null

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Series:
IMF Working Papers
Volume/Issue:
Volume 2016: Issue 196
Language:
English
Publication Date:
29 Sep 2016
DOI:
https://doi.org/10.5089/9781475543254.001
ISBN:
9781475543254
ISSN:
1018-5941
Pages:
37
Keywords:
WP; labor market; executive compensation; risk taking; risk shifting; underinvestment; asset return volatility; payoff schedule; market portfolio; base pay; composite index; incentive contract; schedule of shareholder; Bonuses; Labor markets; Labor mobility; Commercial banks; Asia and Pacific; Europe
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IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
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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.
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Cover IMF Working Papers
IMF Working Papers
ISSN:
1018-5941
Publisher:
International Monetary Fund