Bankers' compensation before and after the 2007-2008 crisis

Abstract

This paper examines the effect of recent regulations on executive incentive compensation contracting among US banks. Following regulations (the Guidance on Sound Incentive Compensation Policies and the Dodd-Frank Act Section 956) intended to prevent incentive compensation arrangements that encourage imprudent risk-taking, I test whether pay-for-performance is weaker and the penalty for downside tail risk is stronger in the post-crisis period as compared to the pre-crisis period. Specifically, I compare the impact of the regulations on large banks versus small banks, using the latter to control for concurrent events. Consistent with regulatory intent, I find evidence of weaker pay-for-performance and larger penalties for downside tail risk for CEOs of large banks in the post-crisis years, as compared to small banks. Together, the results provide evidence on the effectiveness of new regulations in curbing bank CEOs’ incentives, as well as introduce downside tail risk as a determinant of compensation in the banking industry