Optimal bonuses and deferred pay for bank employees: implications of hidden actions with persistent effects in time

Arantxa Jarque and Edward Prescott

No 10-16, Working Paper from Federal Reserve Bank of Richmond

Abstract: We present a sequence of two-period models of incentive-based compensation in order to understand how the properties of optimal compensation structures vary with changes in the model environment. Each model corresponds to a different occupation within a bank, such as credit line managers, loan originators, or traders. All models share a common trait: the effects of hidden actions are persistent, and hence are revealed over time. We characterize the corresponding optimal contracts that are consistent with prudent risk taking. We compare the contracts by ranking them according to the average wage, the proportion of deferred compensation, and the structure and importance of variable pay (bonuses). We also compare these characteristics of the models with persistence with those of a standard repeated moral hazard. We find that small changes in the structure of asymmetric information have important implications for the characteristics of optimal pay, and that persistence does not necessarily imply a higher proportion of deferred pay.

Keywords: Financial institutions; Financial markets; Labor market; Moral hazard (search for similar items in EconPapers)
Date: 2010
New Economics Papers: this item is included in nep-ban, nep-bec, nep-cta and nep-lab
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Citations: View citations in EconPapers (5)

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Working Paper: Optimal bonuses and deferred pay for bank employees: implications of hidden actions with persistent effects in time (2011)
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