Abstract
The recent global financial crisis (GFC) has put under scrutiny the sound remuneration policy and consequently the incentives design that influences risk-taking by managers in the banking industry to be a politically charged variable. In particular, this paper analyzes the new EU remuneration regulation of bank executive compensation and the role of corporate social responsibility (CSR) on this. Though all the EU efforts put into remuneration practices suggest commitment in aligning risk, performance, and compensation and aim at easing bank managers’ risk appetite for variable payments, the new regulation might drive unintended consequences, creating adverse selection problems in EU banks and hidden compensation habits that lower transparency, thus threatening financial system’s sustainability. Focusing on European Banking Authority (EBA) reports spanning from 2010 to 2017, the data reveals increasing values on the fixed component, less involvement in bank discipline by economic agents, and a potential for accounting-based incentives compensation that might reinforce attitudes towards building countercyclical buffers and smoothing earnings. As well, the new regulation might reduce the number of best-performing bank managers in the Eurozone, since “bad risks” are accepted to the detriment of “good risks,” which might stimulate their migration. In contrast, CSR investment is supposed to offset such practices and incentives that harm EU financial stability. As a result, policymakers, banks, and regulators should promote the transparency of CSR disclosure.
Highlights
Despite all the attempts to figure out the precise factors that contributed to the recent global financial crisis (GFC), the answer is still inconclusive but firm in some elements
One of these parts was the restatement of the global corporate governance (CG) principles of financial firms presupposing that governance failures were heavily responsible for these institutions’ deficiencies during the GFC [1]
The GFC has absolutely put under severe scrutiny remuneration policy and the incentives design that affects risk-taking by managers in the banking industry [3], influencing the sustainability of its operating practices
Summary
Despite all the attempts to figure out the precise factors that contributed to the recent global financial crisis (GFC), the answer is still inconclusive but firm in some elements. The GFC has absolutely put under severe scrutiny remuneration policy and the incentives design that affects risk-taking by managers in the banking industry [3], influencing the sustainability of its operating practices. Having a restrictive cap on executive bonuses (which is defined as having above-market salaries and high but capped bonus opportunities), more complex remuneration schemes, and risk management assessment may lead to perverse incentives by bank managers that might threaten the financial system’s sustainability: (i) increasing the fixed component; (ii) less involvement in bank discipline by economic agents; (iii) boosting earnings management, and income smoothing practices in particular, since they create incentives to accept “bad risks” and reject “good risks”
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