Pay-performance sensitivity of compensation contracts for nonexecutive employees: the case of the financial crisis

Abstract

In the aftermath of the recent financial crisis, the appropriateness of bonus payments for employees in the banking and financial services sector has been discussed controversially. While past research has predominantly focused on the pay-performance sensitivity for CEOs or top executive employees, little is known about this relationship for employees below the top executive level. We contribute to the literature by investigating a large sample of German and Swiss banks and find that nonexecutive bonus payments significantly followed firm performance prior to the financial crisis, but this effect vanished in the crisis period. Furthermore, in both periods, the estimated performance sensitivity is higher when negative returns are capped at zero.

Keywords:

• pay-performance sensitivity
• pay for performance
• bonus payments
• financial industry
• nonexecutive employees

JEL Classification:

• D22
• G21
• J33
• M12
• M52

Acknowledgements

I thank Andrew Kinder, Tommaso Reggiani, Rainer Michael Rilke, Marina Schröder, Dirk Sliwka, and Daniel Wiesen for their helpful comments and suggestions.

Notes

¹ See, for instance, “Federal Report Faults Banks on Huge Bonuses” (New York Times, 22 July 2010) or, for Germany, http://www.spiegel.de/international/business/shameless-greed-global-rage-at-bankers-bonus-excesses-a-608993.html.

² The maximum is 220%, which implies that the bonus is more than double the size of the fixed salary.

³ For details on German banks, see Kampkötter and Sliwka (2011).

⁴ Murphy (1999) reports an industry-wide pay-performance elasticity of 0.26 (i.e. a 1% increase in shareholder wealth leads to an increase in CEO cash compensation of 0.26%) and an elasticity of 0.49 for financial firms.

⁵ Using a first-differences model with firm fixed effects instead leads to a very similar coefficient of 0.23.

⁶ See, for instance, http://www.bloomberg.com/news/2013-02-05/ubs-bonus-plan-gives-bankers-incentives-to-take-less-risk.html.