Excessive Leverage and Bankers’ Incentives: Refocusing the Debate

32 Pages Posted: 4 Dec 2017

See all articles by Emilios Avgouleas

Emilios Avgouleas

University of Edinburgh - School of Law

Jay Cullen

Edge Hill University School of Law, Criminology and Policing; University of Oslo

Date Written: March 30, 2015

Abstract

High leverage levels can lead to virtually limitless expansion of bank asset size, which maximizes, in the short to medium term, banks’ return on equity. In the absence of regulatory controls on leverage, all it takes to assume excessive risks, even for benign bankers, is to imitate competitor business strategies and herd. This form of herding is not solely motivated by compensation considerations, but also by career (job retention/promotion) concerns. Namely, while bankers’ compensation has been a major factor behind bank short-termism and excessive risk-taking, the availability of high leverage entails serious agency costs even in the absence of compensation incentives. As a result, regulatory reforms that focus on regulation of private compensation contracts ought to be supplemented by well-calibrated leverage ratios. Otherwise, they are bound to produce, in the long-term, suboptimal results, notwithstanding the conspicuous political gains of such a strategy.

Suggested Citation

Avgouleas, Emilios and Cullen, Jay, Excessive Leverage and Bankers’ Incentives: Refocusing the Debate (March 30, 2015). Journal of Financial Perspectives, Vol. 3, No. 1, 2015, Available at SSRN: https://ssrn.com/abstract=3080253

Emilios Avgouleas (Contact Author)

University of Edinburgh - School of Law ( email )

Old College
South Bridge
Edinburgh, EH8 9YL
United Kingdom

Jay Cullen

Edge Hill University School of Law, Criminology and Policing ( email )

St Helens Road
Ormskirk, L39 4QP

University of Oslo ( email )

PO Box 6706 St Olavs plass
Oslo, N-0317
Norway

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

Paper statistics

Downloads
184
Abstract Views
1,005
Rank
296,243
PlumX Metrics