Banks’ Risk Levels May Affect CEO Pay
In recent years banks have seen growing competition for their traditional lending and deposit-taking business model as deregulation and new technology have eroded banking organizations’ advantages in these areas. At the same time, banking deregulation has increased banks’ set of investment opportunities. As a result, banking organizations have broadened their business to include such activities as municipal revenue bond underwriting, commercial paper underwriting, discount brokering, underwriting mortgage-backed securities, managing and advising mutual funds, and selling insurance products and annuities.
This shift in a bank’s product mix increases its exposure to risk and potentially increases the volatility of its earnings. Such product expansion also affords a bank’s management greater discretion in determining the bank’s business model. According to a recent Atlanta Fed working paper, both the level of management discretion and the level of a bank’s risk correlate to the structure of its CEO’s compensation. Authors Elijah Brewer III, William Curt Hunter, and William E. Jackson III find that equity-based CEO compensation has become more prevalent since the 1990s, a period of significant deregulation in the banking industry.
The authors examine the relationship between the structure of bank CEO compensation and banking organizations’ financial characteristics from 1992 to 2000. Their analysis shows that banks that developed greater exposure to risk during this period provide their CEOs with higher levels of equity-based compensation such as stock options and restricted stock. Also, as a bank moves its product mix toward fee-based activities and away from traditional banking activities, equity-based compensation increases and, in the view of some, aligns the interests of shareholders and bank management.
However, the authors also note that a shift away from traditional banking activities could make it more difficult for shareholders to evaluate an executive’s actions and provides no assurance that his or her behavior will conform to shareholders’ expectations.