Discussion paper

DP8852 Bank Bonuses and Bail-outs

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.


Schnabel, I and H Hakenes (2012), ‘DP8852 Bank Bonuses and Bail-outs‘, CEPR Discussion Paper No. 8852. CEPR Press, Paris & London. https://cepr.org/publications/dp8852