How are Bankers Paid?

How are Bankers Paid?

Benjamin Bennett, Radhakrishnan Gopalan, Anjan Thakor

March 31 2020

Bank executive incentives and compensation have been in the spotlight since the 2007-2009 financial crisis. Some claim that there was a corporate governance failure in bankers’ compensation—the perverse risk-taking incentives spawned by the way bankers were compensated were at least partly to blame for the crisis. However, much of this criticism is in a vacuum—we know very little, by way of systematic empirical evidence, about bank executive compensation. Our recent paper, How are Bankers Paid?, fills this void. We study the characteristics of bank executive compensation using bank holding company data. Our analysis focuses on the time series of pay, the sensitivity of pay to performance, the levels of performance-based pay, and the correlation between bankers’ pay characteristics to observable attributes of banks, like capital ratios, size, etc. We also compare bank pay to non-bank pay.

Our first results relate bank-relevant factors to bank CEO compensation. We find that bank CEO pay is positively related to: firm size, capital (equity) ratio, earnings, and the fraction of non-interest income. We find that nonperforming loans and total pay are negatively related. In terms of governance, bank CEOs with a higher percentage of co-opted boards and a higher E-Index have higher pay. In the time series, we find that relative to the pre-crisis period (2006-2007), bank pay was lower during the crisis (2008-1010), but higher in the most recent period (2014-2018).

Our second set of results relate to the sensitivity of pay to performance. We consider three firm performance measures: ROA, ROE (return on equity) and stock return. We find a strong relation between all three measures and both the pay and firm-related wealth of the CEO, and this relationship has strengthened significantly in the post-crisis period.

Our third set of results relate to how bankers’ pay has changed over time. We examine the time-series of performance-based pay (pay that is explicitly linked to specific firm goals). Relative to the pre-crisis period (2006-2007), total performance-based pay is significantly higher post-crisis (2011-2018). This is mainly driven by higher accounting-based performance pay; the percentage of pay linked to accounting goals is 19.1% higher in 2014-2018 compared to the pre-crisis period (2006-2007). Pay linked to stock price is 5.4% higher in the 2014-2018 period relative to the pre-crisis period (2006-2007). Regarding specific accounting goals, we find an 11.4% increase in the portion of bank CEO pay linked to ROA (return on assets) goals in the most recent period compared to before the crisis.

In our fourth set of results, we turn to a comparison of bankers’ compensation to non-bank CEOs’ compensation. We compare bank CEO pay to CEO pay at: i) non-bank financial firms and ii) non-financial firms. We find that bank CEOs earn less than both non-bank financial and non-financial CEOs. Much of this difference comes from small banks. We find that large bank CEOs earn more than non-bank financial CEOs and earn about the same non-financial firm CEOs. On the other hand, small bank CEOs earn less than both non-bank financial firm and non-financial firm CEOs.

In terms of pay and wealth performance sensitivity, we find that the sensitivity of pay and wealth  to ROA and stock return is greater for bank CEOs than for non-financial firm CEOs, and about the same for bank CEOs as it is for non-bank financial firm CEOs.

Finally, we look at the link between firm risk and different types of performance-based pay. We find that the bigger the portion of a bank CEO’s pay that is linked to accounting performance measures (ROE, ROA), the higher is bank risk.

In a nutshell, therefore, it appears that bankers are compensated in ways that differ from their counterparts in not only non-financial firms but also non-bank financial firms. Accounting measures of performance matter greatly in the computation of bankers’ bonuses.

Authors

Real name:
Benjamin Bennett
Real name:
Radhakrishnan Gopalan
Real name:
Research Member
John M. Olin School of Business, Washington University, St. Louis