Is Capping Executive Bonuses Useful?

Author/Editor:

Kentaro Asai

Publication Date:

September 29, 2016

Electronic Access:

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Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary:

This paper develops a theoretical framework to study the impact of bonus caps on banks’ risk taking. In the model, labor market price adjustments can offset the direct effects of bonus caps. The calibrated model suggests that bonus caps are only effective when bank executives’ mobility is restricted. It also suggests, irrespective of the degree of labor market mobility, bonus caps simultaneously reduce risk shifting by bank executives (too much risk taking because of limited liability), but aggravate underinvestment (bank executives foregoing risky but productive projects). Hence, the welfare effects of bonus caps critically depend on initial conditions, including the relative importance of risk shifting versus underinvestment.

Series:

Working Paper No. 2016/196

Subject:

Banking Bonuses Commercial banks Financial institutions Labor Labor markets Labor mobility Tax incentives

English

Publication Date:

September 29, 2016

ISBN/ISSN:

9781475543254/1018-5941

Stock No:

WPIEA2016196

Pages:

37

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