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Bank Bonuses and Bail-Outs

MPS-Authors
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Hakenes,  Hendrik
Max Planck Institute for Research on Collective Goods, Max Planck Society;

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Schnabel,  Isabel
Max Planck Institute for Research on Collective Goods, Max Planck Society;

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Citation

Hakenes, H., & Schnabel, I. (2013). Bank Bonuses and Bail-Outs.


Cite as: http://hdl.handle.net/11858/00-001M-0000-0028-6E56-D
Abstract
This paper shows that bonus contracts may arise endogenously as a response to agency problems within banks, and analyzes how compensation schemes change in reaction to anticipated bail-outs. If there is a risk-shifting problem, bail-out expectations lead to steeper bonus schemes and even more risk-taking. If there is an effort problem, the compensation scheme becomes flatter and effort decreases. If both types of agency problems are present, a sufficiently large increase in bailout perceptions makes it optimal for a welfare-maximizing regulator to impose caps on bank bonuses. In contrast, raising managers’ liability can be counterproductive.