XXV Edition

1-2 December 2016"

Relative Performance Banker Compensation and Systemic Risk

Albuquerque Rui, Boston College
Guedes Jose, Catholic University of Portugal
Cabral Luis, New York University

We consider a model of bank competition where risk-neutral shareholders offer contracts to risk-averse bank managers, who in turn choose effort level and portfolio allocations. When the latter include both uncorrelated and correlated projects, we show that, in equilibrium, (a) manager compensation includes relative performance evaluation pay; and (b) the latter leads to a higher level of systemic risk, as managers shift portfolios toward correlated projects. We also provide conditions such that portfolio choices by bank managers and RPE pay by shareholders are strategic complements across banks. Finally, we show that various policy recommendations regarding executive pay are ineffective in reducing systemic risk.

Area: Financial Regulation and Supervision

Keywords: systemic risk, relative performance evaluation, executive compensation, regulation, banking sector

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