Abstract
The relationship between executive compensation and bank risk-taking is one of the core topics of corporate governance theory. Especially after the 2008 global financial crisis, due to the characteristics of banks, such as systemic risk, this relationship has become more important. However, though usually calculated on the basis of cash salary and inside equity, which can promote risk incentives, inside debt was considered a tool for risk reduction in prior empirical analyses. Based on actual bank situations, we had doubts about this relationship and wanted to verify the specific relationship between inside debt and risk. We initiated this research by setting up a theoretical model between inside debt and bank default risk and by simulating the result using data from Wells Fargo & Co. to draw the function image. We are the first to define the three kinds of compensation in three dimensions. Then, considering bankruptcy, we found the black box effect exists. Therefore, different from prior views, pay me later not only reduces but also increases risk. We expect our findings to offer help to the formulation of policies for pay contracts.
Highlights
During the four decades since Jensen and Meckling published their article in 1976 [1], the academic literature on executive compensation has increased
The effect of inside debt on increase the risk is not as strong as inside equity, it is an inaccurate tool used for risk reduction
We examined this relationship but the bank’s possibility of bankruptcy was not considered, cash salary of bankers was paid per year and was irrelevant to the bank risk, and Corollary 4
Summary
During the four decades since Jensen and Meckling published their article in 1976 [1], the academic literature on executive compensation has increased. Sundaram and Yermack [2] first proposed that chief executive officers (CEOs) with high debt-based compensation ( called “inside debt” here) manage their firms conservatively. Per Jensen and Meckling [1], inside debt is defined as benefit pensions and deferred compensation. Sundaram and Yermack [2] defined inside debt as “the promise to pay them fixed sums of cash in the future”. We investigated the true relationship of inside debt and bank risk and found the principle and reason for the relationship, proceeding from reality. We define the total compensation as the sum of cash salary, inside equity, and inside debt from the following aspects: remuneration level, compensation structure level, bank level, measure level, board level, and reform level
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