Designing bankers' pay: Using contingent capital to reduce risk-shifting

Alon Raviv, Jens Hilscher and Sharon Peleg Lazar
Authors registered in the RePEc Author Service: Sharon Peleg-Lazar ()

MPRA Paper from University Library of Munich, Germany

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 instead 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.

Keywords: contingent capital; executive compensation; risk-shifting; banking regulation; coco compensation (search for similar items in EconPapers)
JEL-codes: G2 G21 (search for similar items in EconPapers)
Date: 2021-03
New Economics Papers: this item is included in nep-lma and nep-ore
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