Working Paper: NBER ID: w19472
Authors: Shawn Cole; Martin Kanz; Leora Klapper
Abstract: We use an experiment with commercial bank loan officers to test how performance based compensation affects risk-assessment and lending. High-powered incentives lead to greater screening effort and more profitable lending decisions. This effect, however, is muted by deferred compensation and limited liability, two standard features of loan officer incentive contracts. We find that career concerns and personality traits affect screening behavior, but show that the response to monetary incentives does not vary with traits such as risk-aversion, optimism or overconfidence. Finally, we present evidence that incentive contracts distort the assessment of credit risk, even among trained professionals with many years of experience. Loans evaluated under permissive incentives are rated significantly less risky than the same loans evaluated under pay-for-performance.
Keywords: Performance-based compensation; Risk assessment; Lending decisions; Loan officers; Incentives
JEL Codes: D03; G21; J33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| deferred compensation (J33) | decline in screening effort (I14) |
| individual characteristics (Z13) | influence screening effort (C92) |
| high-powered incentives (M52) | greater screening effort (C83) |
| high-powered incentives (M52) | more profitable lending decisions (G21) |
| volume incentives (L42) | lower quality loans (G21) |
| permissive incentives (H27) | inflate internal risk ratings (G21) |