Discussion Paper Details

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Title: Bank Bonuses and Bail-outs

Author(s): Hendrik Hakenes and Isabel Schnabel

Publication Date: February 2012

Keyword(s): bank bail-outs, bank management compensation, bonus payments, limited and unlimited liability, risk-shifting and underinvestment

Programme Area(s): Financial Economics

Abstract: This paper shows that bonus contracts may arise endogenously as a response to agency problems within banks, and analyzes how compensation schemes change in reaction to anticipated bail-outs. If there is a risk-shifting problem, bail-out expectations lead to steeper bonus schemes and even more risk-taking. If there is an effort problem, the compensation scheme becomes flatter and effort decreases. If both types of agency problems are present, a sufficiently large increase in bail-out perceptions makes it optimal for a welfare-maximizing regulator to impose caps on bank bonuses. In contrast, raising managers? liability is counterproductive.

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Bibliographic Reference

Hakenes, H and Schnabel, I. 2012. 'Bank Bonuses and Bail-outs'. London, Centre for Economic Policy Research.