CEO Remuneration and Risk Taking: Evidence from U.S. Commercial Banks

Date: 3 February 2014

Venue: University of Antwerp - Promotiezaal Grauwzusters, Lange Sint-Annastraat 7 - 2000 Antwerp

PhD candidate: Li Jie

Principal investigator: Prof. dr. Marc De Ceuster

Short description: PhD defense Li Jie - Faculty of Applied Economics

Abstract: The executive compensation practices in the banking industry have been heavily criticized for inducing excessive risk-taking and eventually causing the recent financial crisis. However, the evidence from theoretical and empirical studies is weak and inconsistent.
This dissertation is dedicated to investigating the relationship between executive remuneration and risk-taking for the U.S. commercial banks. We begin with conducting a comprehensive review of the existing academic literature. Then a descriptive study is performed to provide facts and figures about executive compensation in the U.S. banking industry. We go on to conduct two empirical studies. First, we examine whether CEO compensation—designed to align the CEO's interests with those of the shareholders—significantly induces risk-shifting behavior towards other stakeholders. Second, we examine whether the bank default risk is related to CEO equity-based compensation incentives and CEO optimism.
We find that bank CEO compensation has significantly reduced since the beginning of 2000s, particularly during the recent crisis period, and the changes in CEO compensation were primarily driven by the use of equity-linked pay. Contrary to common beliefs, we document original and strong evidence that CEO compensation does not exacerbate risk-shifting. We also find that banks have a lower default risk when their CEOs have higher incentives embedded in their equity-based compensation. These results are consistent with the behavior of risk-averse CEOs, who act more conservatively than shareholders would like them to due to the inability to diversify their human capital and personal firm-related wealth. The evidence also extends previous studies connecting managerial risk-taking to CEO optimism and find that banks have a higher default risk when they have optimistic CEOs in place.