Leverage, CEO Risk-Taking Incentives, and Bank Failure during the 2007–10 Financial Crisis*

Abstract

Usual measures of the risk-taking incentives of bank CEOs do not capture the risk-shifting incentives that the exposure of a CEO’s wealth to his firm’s stock price (delta) creates in highly levered firms. We find evidence consistent with the importance of these incentives for bank CEOs: In a sample of large U.S. financial firms, a higher pre-crisis delta is associated with a significantly higher probability of failure during the 2007–2010 financial crisis in highly levered firms, but not in less levered firms.