Working Paper: CEPR ID: DP8089
Authors: Roman Inderst; Sebastian Pfeil
Abstract: We analyze the interaction between financial institutions' internal compensation policy, the quality of loans, and their securitization decision. We also assess the case for requiring financial institutions to defer bonus pay so as to make incentives more commensurate with the longer-term risk of their transactions. While mandatory deferred compensation can improve the quality of loans, we also show when it has the opposite effect. We further analyze when mandatory deferred compensation can complement a policy that requires financial institutions to retain a minimum exposure to their originated loans, and we discuss the impact of a tax on short-term bonus pay. Generally, our modeling framework allows us to study the interaction of financial institutions' internal agency problems with the external agency problem that arises from securitization.
Keywords: compensation; regulation; securitization
JEL Codes: G21; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| mandatory deferred compensation (J33) | loan quality (G51) |
| incentivizing agents to screen loans effectively (G21) | loan quality (G51) |
| mandatory deferred compensation (J33) | likelihood of default (G33) |
| internal agency problem (D82) | likelihood of default (G33) |
| costs of deferred compensation (J32) | loan quality (G51) |
| mandatory deferred compensation (J33) | commitment problems (C78) |
| regulation alleviating commitment problems (G18) | loan quality (G51) |