Managerial Compensation in the Financial Service Industry

Abstract

CEO compensation in the financial sector has been a controversial topic following the financial crisis. I use a new dataset with detailed information on CEO remuneration of major international banks from 2000 to 2008 to give a comprehensive overview of compensation practices in banking throughout the world, the impact on risk and bank policy choices and the determinants. I show that remuneration had an impact on bank performance during the financial crisis. Banks which endowed their CEO with high risk taking incentives performed worse in the period after the Lehman collapse in terms of accounting performance. Banks which granted more stocks performed better. Using simultaneous equation models I show that over time bank risk has been positively correlated with CEOs' risk taking incentives. From a bank policy perspective high vega low delta CEOs rely on riskier, fee based activities and higher leverage. I investigate the role of corporate governance and regulation on CEO compensation. Banks from countries with strong regulation react stronger to bank risk when setting their compensation contracts, on the other hand they grant more equity based compensation. Weak boards lead banks to rely more on equity based compensation and weak compensation committees implement option contracts with characteristics that are more favorable for the CEO.