Executive Compensation in the Banking Industry and Systemic Risk

In this paper, I investigate empirically whether executive compensation structure contributes to the entire systemic risk among 92 firms that highly contribute to systemic risk from 2000 to 2012. Based on Brownlees and Engle (2011) and Acharya, Pedersen, Philippon, and Richardson (2010), I use SRISK and MES as systemic risk measures. Firstly, I find that the ratio of stock options has a positively significant influence on systemic risk. Also, I find weak evidence that the ratio of cash bonus in compensation structure positively related to systemic risk. However, I find no significant evidence that the ratio of stock grants has a negative relation with systemic risk. It might be caused by the growth trend in non-traditional banking activities. Third, I find that TARP fund induces a manager\u27s risk-seeking. This is because the interests of owners and managers are aligned to take more risk for the purpose of maximizing their own wealth. Fourth, I find that the implementation of FAS123R does not eliminate the effect of granting stock options to take more risk and improve firm value and make the effect stronger even though the rule negatively affects the usage of stock options for executive compensation. Lastly, I find that the positive relationship between stock-based compensation and systemic risk is stronger during the recent financial crisis