A Theory of Bank Regulation and Management Compensation

Kose John · Anthony Saunders · Lemma W. Senbet

324 citations0/0 files storedReview of Financial Studies

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Banking stability, regulation, efficiency Corporate Finance and Governance Insurance and Financial Risk Management

Abstract

We show that concentrating bank regulation on bank capital ratios may be ineffective in controlling risk taking. We propose, instead, a more direct mechanism of influencing bank risk-taking incentives, in which the FDIC insurance premium scheme incorporates incentive features of top-management compensation. With this scheme, we show that bank owners choose an optimal management compensation structure that induces first-best value-maximizing investment choices by a bank's management. We explicitly characterize the parameters of the optimal management compensation structure and the fairly priced FDIC insurance premium in the presence of a single or multiple sources of agency problems.

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References

1976Theory of the firm: Managerial behavior, agency costs and ownership structure 1984Corporate financing and investment decisions when firms have information that investors do not have 1986Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers 1983Bank Runs, Deposit Insurance, and Liquidity 1984Financial Intermediation and Delegated Monitoring 1979Moral Hazard and Observability 1985What's different about banks?1997Inside the black box: What explains differences in the efficiencies of financial institutions?

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