Option Compensation, Risky Mortgage Lending, and the Financial Crisis
46 Pages Posted: 2 Jun 2015 Last revised: 1 Oct 2020
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: Suggested Citation