Bankers’ bonuses and performance sensitivity

Bankers’ bonuses and performance sensitivity

Transparency at the average person asset level has already been the disclosure standard for equity funds and allows a more accurate public assessment and monitoring of bank risk. Here, the long-term benefits with regard to better risk pricing, better governance, and ultimately – better incentive systems – seem large. You will want to follow the low-hanging fruits first?

References

Admati, A R, P M DeMarzo, M F Hellwig, and P C Pfleiderer (2011), “Fallacies, Irrelevant Facts, and Myths in the Discussion of Capital Regulation: Why Bank Equity isn’t Expensive”, Rock Center for Corporate Governance at Stanford University Working Paper No. 86, MPI Collective Goods Preprint, No. 2010/42.

Duffie, D (2011), WHAT SIZE Banks Fail and How to proceed about any of it, Princeton University Press, Princeton and Oxford.

Efing, M, H Hau, P Kampkötter, and J Steinbrecher (2014), “Incentive Pay and Bank Risk-Taking: Evidence from Austrian, German, and Swiss Banks”, CEPR Discussion Paper 10217.

Fahlenbrach, R (2009), “Shareholder Rights, Boards, and CEO Compensation”, Overview of Finance, 13(1), 81-113.

H Hau, and M Thum (2009), “Subprime Crisis and Board (in-)Competence: Private vs. Public Banks in Germany”, Economic Policy, 24(60), 701-751.

Footnotes

1 Previous research has indeed found weaker bank governance to be linked to higher incentive pay (Fahlenbrach 2009) and bank risk (Hau and Thum 2009).

2 A far more detailed analysis of tail risk is unfortunately extremely hard with the limited public data open to us.

3 Sharpe ratio maximisation is the same as the maximisation of the web present value of the lender if trading is highly leveraged: Under normal pre-crisis conditions, a dealer bank may have financed trading positions mostly with overnight repos with the average haircut of under 2%, thus allowing a highly effective leverage ratio of at least 50 (Duffie 2011, page 32). The perfect incentive system of a bank therefore must maximise the Sharpe ratio of trading income, that ought to imply a zero marginal aftereffect of bonus incentives on the Sharpe ratio of trading income.

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