Working Paper: NBER ID: w20468
Authors: Matthias Efing; Harald Hau; Patrick Kampkötter; Johannes Steinbrecher
Abstract: We use payroll data on 1.2 million bank employee years in the Austrian, German, and Swiss banking sector to identify incentive pay in the critical banking segments of treasury/capital market management and investment banking for 66 banks. We document an economically significant correlation of incentive pay with both the level and volatility of bank trading income-particularly for the pre-crisis period 2003--7 for which incentive pay was strongest. This result is robust if we instrument the bonus share in the capital markets divisions with the strength of incentive pay in unrelated bank divisions like retail banking. Moreover, pre-crisis incentive pay appears too strong for an optimal trade-off between trading income and risk which maximizes the NPV of trading income.
Keywords: Incentive Pay; Bank Risk-taking; Trading Income; Financial Regulation
JEL Codes: D22; G01; G20; G21; G38
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Incentive pay (J33) | Trading income (E25) |
| Incentive pay (J33) | Volatility of trading income (G19) |
| Incentive pay (J33) | Sharpe ratio of trading income (G19) |
| Incentive pay (J33) | Misalignment of employee interests (L21) |
| Incentive pay (J33) | Excessive risk-taking (D81) |
| Moderation in pay (J33) | Better alignment with asset value maximization (L21) |