Incentive pay and bank risk-taking: Evidence from Austrian,German, and Swiss banks |
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| Institution: | 1. University of Geneva, GFRI, 40 Bd du Pont d''Arve, 1211 Genève 4, Switzerland;2. Swiss Finance Institute, Switzerland;3. University of Cologne, Albertus-Magnus-Platz, 50923 Cologne, Germany;4. Ifo Institute Branch Dresden, Einsteinstraße 3, 01069 Dresden, Germany;1. Columbia Business School, 3022 Broadway, Uris Hall 601, New York 10027, NY, United States;2. International Monetary Fund, Research Department, 700 19th St, NW, Washington 20431, DC, United States;1. Federal Reserve Bank of San Francisco, United States;2. Department of Economics, University of California, Davis, United States;3. Department of Economics, University of Bonn, Germany;4. CEPR, United Kingdom;5. Graduate School of Management, University of California, Davis, United States;6. NBER, United States;1. Warwick Business School, University of Warwick, United Kingdom;2. CEPR, United Kingdom;3. Bank of England, United Kingdom |
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| Abstract: | We use payroll data in the Austrian, German, and Swiss banking sector to identify incentive pay in the critical banking segments of treasury/capital market management and investment banking for 67 banks. We document an economically significant correlation of incentive pay with both the level and volatility of bank trading income—particularly for the pre-crisis period 2003–2007, in which incentive pay was strongest. This result is robust if we instrument the bonus share in the capital market divisions with the strength of incentive pay in unrelated bank divisions like retail banking. Moreover, pre-crisis incentive pay appears too strong for an optimal trade-off between trading income and risk, which maximizes the net present value of trading income. Further analyses indicate that the bonus moderation during the crisis has removed excessive pre-crisis incentive pay. |
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