DP15081 The economics of deferral and clawback requirements

Author(s): Florian Hoffmann, Roman Inderst, Marcus M. Opp
Publication Date: July 2020
Keyword(s): bonus deferral, clawbacks, compensation regulation, moral hazard, principal-agent models with externalities, Short-termism
JEL(s): D86, G21, G28
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=15081

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.