Designing Bankers' Pay: Using Contingent Capital to Reduce Risk-Shifting Incentives

Jens Hilscher, Sharon Peleg Lazar, Alon Raviv

Research output: Contribution to journalArticlepeer-review

1 Scopus citations

Abstract

Including contingent convertible bonds (coco) in the capital structure of a bank affects the sensitivity to risk of its equity-based compensation. Such risk-shifting incentives can be reduced if the coco bonds are well-designed. Similarly, we show that compensating executives with well-designed coco bonds can also reduce risk-shifting incentives. In practice, however, most coco bonds have characteristics that result in both stock and coco compensation having large sensitivities to changes in asset risk - equity-based compensation encourages executives to increase risk, coco compensation to reduce risk. We show that a pay package combining both stock and coco can practically eliminate risk-shifting incentives and that it can be implemented with a bank's preexisting coco bonds.

Original languageEnglish
Article number2240005
JournalQuarterly Journal of Finance
Volume12
Issue number1
DOIs
StatePublished - 1 Mar 2022

Bibliographical note

Publisher Copyright:
© 2022 World Scientific Publishing Company.

Keywords

  • Banking regulation
  • Coco compensation
  • Contingent capital
  • Executive compensation
  • Risk-shifting

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