Option Compensation, Risky Mortgage Lending, and the Financial Crisis

46 Pages Posted: 2 Jun 2015 Last revised: 1 Oct 2020

See all articles by Yongqiang Chu

Yongqiang Chu

Belk College of Business, UNC Charlotte

Xinming Li

University of South Carolina, Darla Moore School of Business, Department of Finance

Tao Ma

Rawls College of Business, Texas Tech University

Daxuan Zhao

School of Business, Renmin University of China

Date Written: July 19, 2019

Abstract

We examine how option compensation affects banks’ risky mortgage origination and sale decisions before the financial crisis in 2008. We find that, in the period immediately before the financial crisis, option compensation has little impact on the riskiness of mortgages originated and is negatively associated with mortgage lenders’ propensity to sell risky mortgages. Hence, contrary to the wildly held belief, we fail to find evidence that option compensation contributes to risky mortgage lending prior to the financial crisis. Instead, banks react to option compensation by adjusting the sale of risky mortgages. For identification, we use bank-year fixed effects and matched loan applications to control for both supply- and demand-side factors of mortgage lending. We find similar results when using the variation in option compensation generated by the implementation of FAS 123R.

Keywords: Management Compensation, Stock Options, Mortgage, Bank Risk Taking, FAS 123R, HMDA, Securitization

JEL Classification: G30, G32, G38

Suggested Citation

Chu, Yongqiang and Li, Xinming and Ma, Tao and Zhao, Daxuan, Option Compensation, Risky Mortgage Lending, and the Financial Crisis (July 19, 2019). Available at SSRN: https://ssrn.com/abstract=2612918 or http://dx.doi.org/10.2139/ssrn.2612918

Yongqiang Chu (Contact Author)

Belk College of Business, UNC Charlotte ( email )

9201 University City Boulevard
Charlotte, NC 28223
United States
7046877695 (Phone)

Xinming Li

University of South Carolina, Darla Moore School of Business, Department of Finance ( email )

Tao Ma

Rawls College of Business, Texas Tech University ( email )

Box 42101
Lubbock, TX 79409-2101
United States

Daxuan Zhao

School of Business, Renmin University of China ( email )

59 Zhongguancun Street
Beijing, 100872
China

HOME PAGE: http://daxuanzhao.weebly.com/

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