Incentive Compatible Compensation and Regulation

23 Pages Posted: 22 Feb 2013 Last revised: 20 May 2014

See all articles by An Chen

An Chen

Ulm University - Institute of Insurance Science

Date Written: May 19, 2014

Abstract

This paper uses contingent claims analysis and regulatory constraints to show how a bank can create incentive compatible compensation for senior management aligned with the interests of other stakeholders. For this purpose, the remuneration package takes the form of a "call spread'' on the bank's equity. Unlike regular stock option programmes, a call spread limits the upside potential for senior management. This prevents unlimited risk taking. Additionally, a maximum regulatory default probability also constrains risk taking behavior. We show under which parameterizations the remuneration package and the regulatory constraint offer equal incentives for senior management.

Keywords: executive stock option programmes, call spread, default probability, regulation

JEL Classification: G23

Suggested Citation

Chen, An, Incentive Compatible Compensation and Regulation (May 19, 2014). Available at SSRN: https://ssrn.com/abstract=2217368 or http://dx.doi.org/10.2139/ssrn.2217368

An Chen (Contact Author)

Ulm University - Institute of Insurance Science ( email )

Ulm, 89081
Germany

HOME PAGE: http://www.uni-ulm.de/mawi/ivw/team

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
88
Abstract Views
901
Rank
520,585
PlumX Metrics