The impact of legal systems on CEO compensation and bank stability: a cross-country study

Abstract

PurposeRemuneration policies may differ from country to country, and their effect on bank stability could be due to the legal framework. Therefore, this study aims to investigate how the legal system impacts the relationship between CEO compensation and bank stability across countries.Design/methodology/approachTo test the study hypotheses, the authors use panel data of 74 banks operating in ten OECD countries during the period 2009–2016 and apply the generalized moments method regression model to better remediate the endogeneity problem.FindingsThe findings confirm that a country’s banking regulations significantly affect its bank stability. Common law countries have less bank stability than civil law countries. This result can be interpreted by the fact that, in common-law countries, banks’ CEO are strongly protected by the law, so they allocate a large part of bank assets to risky loans to improve their variable remuneration.Practical implicationsThe research can help policymakers understand bank stability in one country. Any legal reform would require prior knowledge of how risk-taking may arise in executive compensation.Originality/valueThe contribution is to explain the controversial effect of executive compensation on bank stability in the framework of legal theory. The authors argue that regulators should monitor compensation structures and that the country’s legal origin of law shapes the CEO compensation structure and is a determinant of bank stability. To the best of the authors’ knowledge, there are no studies exploring this field. So, this study tries to shed more light on the dark side of CEOs’ behavior when undertaking risky projects to maximize their remuneration.