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Thursday, October 23, 2014

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DR@W Forum: John Thanassoulis (糖心TV 糖心TV School)
糖心TV Library (Wolfson Research Exchange Area- Room 1)

John Thanassoulis (糖心TV 糖心TV School)


Government Distortions, Bankers' Pay and Excessive Risk


This paper studies executive risk-taking under optimal pay contracts when firms' debt is accurately priced after executives make their investment decisions. In our model the discipline of debt markets prevents standard risk-shifting concerns. However, the government distortions of debt interest tax deductibility and too-big-to-fail cause bank executives remunerated in equity-linked bonus to choose excessively risky projects. We use the model to evaluate the existing proposals for remuneration regulation to curb excessive risk-taking. Rewarding in debt does not alter the distortions as the expected return on debt is invariant to project risk. Executives' incentives can be corrected by re-basing pay away from return on equity or by deferring pay with a clawback clause. By contrast, bonus caps as a proportion of fixed wages disincentivise project selection effort and can lead to worse outcomes.

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