DP9877 Regulating Deferred Incentive Pay

Author(s): Florian Hoffmann, Roman Inderst, Marcus M. Opp
Publication Date: March 2014
Keyword(s): Compensation design, Financial regulation, Principal-agent models
JEL(s): D86, G21, G28
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=9877

Our paper examines the effect of recent regulatory proposals mandating the deferral of bonus payments and claw-back clauses for compensation contracts in the financial sector. We study a multi-task setting in which a bank employee, the agent, privately chooses (deal or customer) acquisition effort and diligence, which stochastically reduces the occurrence of negative events over time (such as loan defaults or customer cancellations). The key ingredient of the compensation contract is the endogenous timing of a long-term bonus that trades off the cost and benefit of delay resulting from agent impatience and the informational gain, respectively. Our main finding is that government interference with this privately optimal choice may