Working Paper: CEPR ID: DP16882
Authors: Florian Hoffmann; Roman Inderst; Marcus Opp
Abstract: We analyze the effects of regulatory interference in compensation contracts, focusing on recent mandatory deferral and clawback requirements restricting incentive compensation of material risk-takers in the financial sector. Moderate deferral requirements have a robustly positive effect on equilibrium risk-management effort only if the bank manager's outside option is sufficiently high, else, their effectiveness depends on the dynamics of information arrival. Stringent deferral requirements unambiguously backfire. We characterize when regulators should not impose any deferral regulation at all, when it can achieve second-best welfare, when additional clawback requirements are of value, and highlight the interaction with capital regulation.
Keywords: financial regulation; moral hazard; compensation design; clawbacks; bonus deferral; short-termism
JEL Codes: D86; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| moderate deferral requirements (I19) | equilibrium risk management effort (D53) |
| bank manager's outside option is sufficiently high (G21) | equilibrium risk management effort (D53) |
| information arrival dynamics (C69) | equilibrium risk management effort (D53) |
| stringent deferral requirements (H60) | equilibrium risk management effort (D53) |