A Theory of Bank Regulation and Management Compensation

Kose John, Anthony Saunders and Lemma W. Senbet

New York University, Leonard N. Stern School Finance Department Working Paper Seires from New York University, Leonard N. Stern School of Business-

Abstract: This paper examines the incentive structure underlying the current features of bank regulation. We show that capital regulation has limited effectiveness, given the observed high leverage ratios of banks. We propose instead a more direct and effective mechanism of influencing incentives through the role of top-management compensation, whereby a fair and revenue-neutral FDIC premium incorporates incentive features of top-management compensation. With this pricing scheme (for FDIC insurance), we show that bank owners choose an optimal management compensation structure which induces first-best value-maximizing investment choices by a bank's management. We also characterize the parameters of the optimal managerial compensation structure and the FDIC premium schedule explicitly.

Date: 1998-05
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Journal Article: A Theory of Bank Regulation and Management Compensation (2000)
Working Paper: A Theory of Bank Regulation and Management Compensation (1996)
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Persistent link: https://EconPapers.repec.org/RePEc:fth:nystfi:98-043

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