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

Jens Hilscher, Sharon Peleg Lazar () and Alon Raviv
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Sharon Peleg Lazar: Graduate School of Business Administration, Bar-Ilan University, Ramat Gan, Israel

Quarterly Journal of Finance (QJF), 2022, vol. 12, issue 01, 1-22

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.

Keywords: Contingent capital; Executive compensation; Risk-shifting; Banking regulation; Coco compensation (search for similar items in EconPapers)
Date: 2022
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DOI: 10.1142/S2010139222400055

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