Investment Opportunity Set, Product Mix, and the Relationship between Bank CEO Compensation and Risk-Taking

Elijah Brewer III, William Curt Hunter, and William E. Jackson III
Working Paper 2004-36
December 2004

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The product mix changes that have occurred in banking organizations during the 1990s provide a natural experiment for investigating how firms adjust their executive compensation contracts as their mix of businesses changes. Deregulation and new technology have eroded banking organizations’ comparative advantages and have made it easier for nonbank competitors to enter banking organizations’ lending and deposit-taking businesses. In response, banking organizations have shifted their sale mix toward noninterest income by engaging in municipal revenue bond underwriting, commercial paper underwriting, discount brokering, managing and advising open- and close-ended mutual funds, underwriting mortgage-backed securities, selling and underwriting various forms of insurance products, selling annuities, and other investment banking activities via Section 20 subsidiaries. These mix changes could affect firms’ risk and the structure of CEO compensation. The authors find that as the average banking organization tilts its product mix toward fee-based activities and away from traditional activities, equity-based compensation increases. They also find that more risky banks have significantly higher levels of equity-based compensation, as do banks with more investment opportunities. But, more levered banks do not have higher levels of equity-based CEO compensation. Finally, the authors observe that equity-based compensation is more important after the Riegle-Neal Act of 1994.

JEL classification: G32; G34; G38; G21

Key words: corporate governance, executive compensation, product mix, risk-taking, bank holding companies

The authors thank Beth Cooperman, James R. Marchand, seminar participants at the Federal Reserve Banks of Atlanta, Chicago, and Cleveland, and session participants at the 2003 FMA meetings for many helpful suggestions. The research assistance of Millard F. Southern III is greatly appreciated. The views expressed here are the authors’ and not necessarily those of the Federal Reserve Bank of Atlanta or Chicago or of the Federal Reserve System. Any remaining errors are the authors’ responsibility.

Please address questions regarding content to Elijah Brewer III, Research Department, Federal Reserve Bank of Chicago, 11th Floor, 230 S. LaSalle Street, Chicago, Illinois 60604-1413, 312-322-5813,; William Curt Hunter, Dean and Distinguished Professor of Finance, School of Business, University of Connecticut, 2100 Hillside Road, Unit 1041, Storrs, Connecticut 06269-1041; or William E. Jackson III, Federal Reserve Bank of Atlanta, Research Department, 1000 Peachtree Street, N.E., Atlanta, Georgia 30309, 404-498-8708,, and The Kenan-Flagler Business School, University of North Carolina at Chapel Hill.