Bonding Bankers: Notes Toward a Governance Approach to Risk Regulation

Important regulatory failures have been identified in the wake of the recent financial crisis, and comprehensive regulatory reform has been much on the minds of policymakers. Reform proposals call for a number of significant changes to the scope and structure of financial regulation to address systemic risk. With banking regulation, however, the twin tools of capital requirements and external supervision seem to remain the dominant regulatory levers. In this short discussion, I introduce the contours of an important supplement to the existing approach, a governance approach that uses bank executives\u27 compensation arrangements as a policy lever. I propose that bank executives receive some portion of their compensation in the form of their own bank\u27s publicly issued debt securities. Taking a page from the pay-for-performance movement, I argue that paying bank executives-at least in part-with bank debt securities can blunt the risk taking proclivities that shareholder-centered corporate governance encourages and that equity-based compensation exacerbates. My proposal piggybacks on prior suggestions that banks be required to issue subordinated debt as a device to induce market discipline to counter excessive risk taking