The impact of Incentives and risk-taking: Evidence from the UK banking sector

It has been argued that poor remuneration policies at financial institutions were a major contributor to the 2008 financial crisis. Consequently, global regulators have developed several remuneration codes of conduct for designing incentive schemes whereby the behaviour of employees under those schemes are more aligned with the relationship between risk and return. The primary aim of these remuneration codes is to mitigate employees’ propensity for excessive risk-taking. In view of these changes, the purpose of this paper is to examine the impact of the three most prominent changes brought about by these codes: a bonus cap; deferral of bonus payments; and a clawback clause on bonuses, on traders’ risk-taking behaviour. We present a qualitative analysis of semi-structured interviews with bankers from ten large investment banks. The findings indicate that bonus deferrals have no impact on risk-taking behaviour, with the impact of a bonus cap and bonus clawback being contingent upon the circumstances in which they are implemented. We conclude that uncapped pay-per-performance incentive schemes encourage risk-taking, and that the vital ingredient in reducing traders’ propensity for excessive risk-taking is the commitment of senior management to a strong risk culture, not the remuneration codes