20.5.2011
By Simon Miller
Higher bonuses lead to higher risk taking according to research carried out by Edinburgh and Leeds University.
The study found that banking executives were more likely to take greater risk when they are personally compensated for doing so.
CEO pay incentives and risk-taking: Evidence from bank acquisitions by Jens Hagendorff and Francesco Vallascas Banks studied US bank acquisitions from 1993-2007 and found that chief executives receive substantial bonuses for completing acquisitions are more likely to carry out risky takeovers and mergers.
Consequently, the amount of risk taken on by banks – a major factor in the ongoing credit crunch – is a direct result of the amount of incentives given to banking executives.
As the link between executive pay and bank risk encourages financial volatility, regulators should consider limiting the incentives, such as stock options, that bankers receive, the researchers claim.
Jens Hagendorff, senior lecturer at the University of Edinburgh Business School, said: “Chief executive pay in banking is much more geared towards rewarding risk-taking than in any other industry. Our research shows that banking chief executives are clearly responsive to the risk-taking incentives they receive.
“Since concerns over financial stability are one of the main reasons for regulating banking, the links between risk-taking and chief executive pay support the case for regulating compensation in the banking industry.”
Researchers found that during the 1993-2007 period studied, chief executives were offered increasingly large amounts of risk-based compensation. They also found that banks whose chief executives received higher incentives engaged in riskier behaviour than they had previously.
Francesco Vallascas, lecturer in Banking and Finance at Leeds University Business School, said: “With parts of the world still reeling from the sub-prime crisis, executive pay in the banking industry is more contentious than ever. But our results show a clear link between executive pay and risky behaviour in banks. Regulating bankers' pay is an issue that deserves consideration, no matter how controversial it is.”
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