![]() ![]() The paper also looks at how the bonus cap affected bank executives’ turnover, as restrictions on their bonus could lead them to move to non-banks (eg hedge funds) which are not subject to the bonus cap rule. Colonnello et al (2018) examine the impact of the EU bonus cap and find that the risk-adjusted performance of EU banks deteriorated following the introduction of the bonus cap in 2014, possibly because the bonus cap reduced incentive to perform. There is only a handful of empirical studies on the impact of the bonus cap rule. This is because in a competitive market for bankers, total pay will be determined by the banker’s ability and the bank’s size. Thanassoulis (2012) highlights the unintended consequences of a bonus cap, arguing that it would shift pay from bonuses to fixed salaries, and thereby increase banks’ fixed costs and their probability of failure. They show that banks can restore excessive risk-taking even in the presence of a clawback rule by offering a bonus which rises more than proportionally with (ie convex in) the equity returns, and that a bonus cap does not prevent this. Thanassoulis and Tanaka (2018) also consider the impact of regulating bankers’ pay when banks’ incentives are distorted by TBTF, but they explicitly analyse the possibility that banks adjust the sensitivity of bonus to equity returns in response to regulation. It also does not consider the possibility that banks may adjust the pay structure in response to the regulation. Their analysis, however, assumes that bankers are rewarded in bonus only and so a bonus cap also puts a limit on total reward from risk-taking. For example, Hakenes and Schnabel (2014) argue that the case for a bonus cap arises when banks have a strong incentive to encourage excessive risk-taking by offering a large bonus, in order to exploit the implicit taxpayer subsidy arising from TBTF. The theoretical literature on the effectiveness of the bonus cap in preventing excessive risk-taking is mixed. Thus, the existing bonus cap rule can be justified only if capping the ratio of variable-to-fixed pay can improve on the market outcome. Crucially, the existing bonus cap rule limits the ratio of variable-to-fixed pay, but it does not limit the total pay or total bonus. The bonus cap rule in the EU and the UK restricts the variable pay of MRTs at banks to be no more than 100% of their fixed pay, or 200% with shareholders’ approval. By contrast, the bonus cap is supposed to mitigate excessive risk-taking by limiting the reward from risky bets. This includes requirements to delay the payment of a part of the bonus (‘deferral’) and pay a proportion of it in bank shares, where deferred bonuses can be withdrawn if adverse circumstances materialise before the deferred bonus is paid out (‘malus’) or even after it is paid out (‘clawback’). Some of the UK remuneration rules aim to reduce short-termism and excessive risk-taking in banks by exposing the so-called material risk-takers’ (MRTs’) compensation to losses which may materialise over a longer time horizon. The aim of the post-GFC remuneration rules was to rectify this asymmetry in bankers’ reward structure. In order to maximise the implicit subsidy for risk-taking arising from these, banks would incentivise excessive risk-taking by rewarding their employees with a high bonus when their risky bet succeeds, without penalising them when it fails. This could happen when banks are ‘too big to fail’ (TBTF), or when the deposit insurance premium is mispriced. The case for post-GFC remuneration rules was based on the argument that the market-determined pay of bankers incentivised excessive risk-taking and short-termism. Indeed, some studies (eg Rosen (1981) Gabaix and Landier (2008) Edmans and Gabaix (2016)) explained how both the rise in the level of executive remuneration and the very large levels of compensation for the most senior employees could reflect the efficient outcome of a competitive market for talent against the backdrop of growth, globalisation and technological advances. A high bonus itself is not an evidence of a market failure. In the absence of any market failure, there is no case for regulating pay, as firms would offer a compensation package that incentivises their employees to take appropriate levels of risk. So what is the economic case for regulating bankers’ pay? In general, regulation is justified if two conditions are met: first, a market failure is identified, and second, the regulation improves on the market outcome.
0 Comments
Leave a Reply. |
AuthorWrite something about yourself. No need to be fancy, just an overview. ArchivesCategories |