Exploring the effects of the ‘bonus cap’ rule: the impact of remuneration structure on risk-taking by bank managers

Abstract

ABSTRACTThis article explores the effects of the bonus cap rule on UK banks to assess its impact on incentives faced by senior managers to make risky decisions. It is demonstrated that the ratio of variable to fixed remuneration is only one of the factors that determine the intensity of financial incentives to make risky decisions. More crucially, the steps taken by major UK banks to evade the effects of the cap by introducing fixed pay allowances, which are paid in shares but are legally structured as fixed remuneration, have created additional risk-taking incentives. Indeed, it is shown that paying part of executive remuneration in shares as such, is a significant driver of risk-taking. It follows that there is no reason to believe that the bonus cap has achieved any improvement in incentives and, therefore, that EU law’s emphasis on the ratio of variable to fixed remuneration is misplaced.