CEO Pay Gaps and Bank Risk-Taking

Abstract

Bank executives’ substantial compensation is seen as one of the factors that contributed to the risk-taking that led to the 2008–2009 financial crisis. We test whether and how pay disparities between CEO and non-CEO executives—the so-called CEO pay gap—influences risk-taking at publicly traded commercial banks in the U.S. We find strong evidence that larger CEO pay gaps are associated with lower risk levels, improved financial performance, and greater information transparency. Our findings are unique to banks and are consistent with the CEO power proposition. We corroborate this proposition by linking larger pay gaps to increased CEO power and low CEO turnover-performance sensitivity. Our results imply that placing absolute limits on bank CEO pay would likely result in increased bank risk-taking.

Keywords:

• Bank risk-taking
• CEO power
• CEO pay gap
• Executive compensation, Tournament incentive
• Discretionary loan loss provision
• Performance

JEL classification:

• G01
• G21
• G32
• G34
• J33
• M12
• M52

Data Availability

Unless noted otherwise, all data are available from the commercial sources identified in the text.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 See, respectively, the European Banking Authority (2015), Squam Lake (2010), the Federal Reserve (2010, 2011, 2016), and SEC Rule 14a-21(a), which implemented Section 951 of the Dodd–Frank Wall Street Reform and Consumer Protection Act (2010).

2 Other studies of non-financial firms find that the CEO pay gap is associated with poor firm performance (Bebchuk et al., 2011), increased fraud (Haß et al., 2015), and increased innovation (Shen & Zhang, 2018).

3 In this way, the CEO power hypothesis is the ‘quiet life’ hypothesis (Bertrand & Mullainathan, 2003).

4 Our main findings are robust to including these crisis period observations. See Appendix Table A1.

5 The right-truncated BHCs in Figure 2 appear in all 19 years of our data: Bank of America Corporation, Bank of Hawaii Corporation, City National Corporation, Comerica Incorporated, Fifth Third Bancorp, First Horizon National Corporation, Huntington Bancshares Incorporated, JPMorgan Chase & Company, Northern Trust Corporation, PNC Financial Services Group Inc., State Street Corporation, Suntrust Banks Inc., U.S. Bancorp, and Wells Fargo & Company.

6 The first of these seven results is calculated as (0.11×-0.005)/0.0182 = 0.0302, where 0.11 is the standard deviation of paygap, -.005 is the regression coefficient on PayGap, and 0.0182 is the mean value of Total Risk. The next five results are calculated similarly. The last of the seven results is calculated as 0.11×-0.661/0.48 =  0.1515, where 0.48 is the standard deviation of the inverse Z-score. 

7 All of the main results in Table 3 are robust to excluding global, systemically important banks (GSIBS). 

8 Our main results are robust to adding CEO characteristics (delta, vega, overconfidence, age, tenure, and female_ceo) to the vector X of the control variables. See Appendix Table A2.

9 The number of banks and bank-year observations vary across the panels in Table 4, according to whether or not executives at bank i received that type of pay in year t-1.

10 The coefficient on derivatives hedging ratio is negative and statistically significant in the OLS tests but it becomes statistically insignificant in the instrumental variables tests. The unexpected negative sign may simply indicate that high paygap banks take on less interest rate, foreign exchange, and market risk, and as such have less need to hedge against these risks.

11 The market for new issues of private-issue MBS in the U.S. collapsed to near-zero volumes in 2008, but many of the securities issued prior to that period remained on banks’ balance sheets for a number of years because they were backed by long-run mortgage loans.

12 See Appendix Table A3. 

Additional information

Funding

This work was supported by Australian Research Council [Grant Number DE140100253].