Abstract
This study investigates the mediation effect of the pay-risk sensitivity of CEOs on the relation between risky investment and bank performance over the sample period of 2000 to 2007. The empirical results of the study show that CEOs of BHCs engage in more private MBSs will increase their pay-risk sensitivity incentives, and then induces the relation between risky investment and bank performance to become negative. These results imply that the pay-risk sensitivity incentives indirectly induce manager to increase his own benefits at the expense of shareholders. Furthermore, we classify CEOs of BHCs as three levels of overconfidence, and find that the pay-risk sensitivity incentive has a mediation effect on the relation between private MBSs and firm performance in excessively overconfident CEOs group, implying that the levels of CEOs confidence should be considered while compensation committee designs a flawless contract for encouraging managers put shareholders' best interests in front of theirs.
Highlights
The risky investment and the risk sensitivity of CEO are important issues in recent bank’s financial management
In terms of mediation effect of CEOs pay-risk sensitivity, we find that α2 is significantly negative in all samples, excessively overconfident CEOs group and moderately overconfident CEOs group, implying that the CEO pay-risk sensitivity directly and negatively affects the bank’s performance
This table shows that coefficients of α2 and α5 are significantly in all samples and excessively overconfident CEOs group, supporting that the mediation effect of CEO pay-risk sensitivity exists in all sample and excessively overconfident CEOs group but not appears in excessively diffident CEOs group and moderately overconfident CEOs group
Summary
The risky investment and the risk sensitivity of CEO are important issues in recent bank’s financial management. The passage of the Financial Services Modernization Act in 1999 and effectively abolishing the Glass-Steagall in 1933 allowed banks to engage in a range of new fee earnings activities such as underwriting of commercial paper, mortgage backed and asset backed securities or other investment activities. These new fee earnings activities induce a decline in interest margins induced by higher competition, and the traditional function of banks as financial intermediaries has been in decline (Allen and Santomero [1]). To clarify the relation between bank’s performance and risky investment, this study uses the CEOs pay-risk sensitivity to analyze the effect of risk sensitivity of CEO on the relation between bank’s performance and risky investment
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