Journal of Economics and Business 63 (2011) 456471

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Journal of Economics and Business

CEO incentives and bank risk

James Cash Acrey , William R. McCumber, Thu Hien T. Nguyen
Department of Finance, Sam M. Walton College of Business, University of Arkansas, Fayetteville, AR 72701, United States

a r t i c l e

i n f o

a b s t r a c t
We investigate the relationship between CEO compensation and bank default risk predictors to determine if short-term incentives can explain recent excesses in bank risk. We investigate early warning off-site surveillance parameters and expected default frequency (EDF) as well as crisis-related risky bank activities. We nd only modest evidence that CEO compensation structures promote signicant rm-specic heterogeneity in bank risk measures or risky activities. Compensation elements commonly thought to be the riskiest components, unvested options and bonuses, are either insignicant or negatively correlated with common risk variables, and only positively signicant in predicting the level of trading assets and securitization income. 2010 Elsevier Inc. All rights reserved.

Article history: Received 2 February 2010 Received in revised form 30 August 2010 Accepted 20 September 2010 JEL classication: G01 G21 G32 J33 Keywords: CEO compensation Bank risk Bank regulation Bank failure Bank EDF

1. Introduction and motivation This economic crisis began as a nancial crisis, when banks and nancial institutions took huge, reckless risks in pursuit of quick prots and massive bonuses. When the dust settled, and this

Special consideration should be given to this paper due to the timeliness of bank reform legislation and the growing popular outcry about bank CEO composition. The data was collected from ExecuComp and Y9-C reports. The paper offers conrmation of the Fahlenbrach and Stulz (2009) nding of incentive alignment between shareholders and bank CEOs, uses estimates of bank default probabilities common to industry, and expands the literature on CEO compensation, bank CEO compensation, bank specialness, bank failure, systemic banking risk, EDF, banking regulation, and agency theory. Corresponding author. Tel.: +1 501 413 9047.

E-mail addresses: jacrey@walton.uark.edu (J.C. Acrey), WMcCumber@walton.uark.edu (W.R. McCumber), TNguyen@walton.uark.edu (T.H.T. Nguyen). 0148-6195/$ see front matter 2010 Elsevier Inc. All rights reserved. doi:10.1016/j.jeconbus.2010.09.002

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binge of irresponsibility was over, several of the worlds oldest and largest nancial institutions had collapsed, or were on the verge of doing so (President Barack Obama, January 21, 2010). Bank executives faced widespread criticism in the wake of the nancial crisis for privatizing gains and socializing losses1 . New York Attorney General Andrew Cuomo blasted the Heads I Win, Tails You Lose culture of bank bonuses, claiming banks abuse the governments safety net to capture upside gains without suffering downside losses because rapid compensation ination during good times remains high during periods of poor bank performance (Cuomo, 2009). Two dozen bank CEOs collectively gained over $90 million in stock options during the crisis, further fueling public outrage (Gomstyn, 2009). The FDIC recently approved a policy to set deposit insurance premiums based, in part, on compensation practice. At the time of this writing, Congress and the Obama administration are attempting to force banks to dramatically change executive compensation. H.R. bill 3269 aims to align compensation with long-term bank performance to reduce any preferences for short-term prots at the expense of long-term bank solvency. The bill directs the Comptroller General of the United States to undertake a rigorous study to determine whether there is a correlation between compensation structures and excessive risk taking that contributed to the crisis. We motivate this research with the same objective. Arguments for regulating compensation to curtail bank risk-taking critically assume that CEO compensation must drive bank risk. The contribution is by no means an established empirical fact. Fahlenbrach and Stulz (2009) nd no substantial evidence of agency problems during the nancial crisis that can be linked to bank CEO compensation. Gorton (2009) details complications in regulating pay in a banking system increasingly dominated by shadow banking and pressured by a ercely competitive labor market. Levine (2004) advocates increased transparency to relieve regulators and allow market discipline to punish overly aggressive risk-taking. This market-based narrative lends support to those who blame regulators and government interference for the crisis. We study the explanatory power of CEO compensation on common bank default risk measures and, ex post, crisis-sensitive risky bank activities. We nd only modest evidence that structural differences in bank CEO compensation, or any specic elements of CEO compensation, predict rm-specic heterogeneity in bank risk-taking activities. Our evidence lends support to the Fahlenbrach and Stulz (2009) conclusion that CEO compensation was not a cause of the nancial crisis and does not explain bank risk. The remainder of this paper proceeds as follows: Section 2 reviews the relevant literature. Section 3 develops our testable hypotheses. Section 4 describes our sample and denes our variables. Section 5 details our methodology. Section 6 reports our results. Section 7 concludes and offers avenues for future research. 2. Literature review Murphy (1999) claims that compensation plans should align the interests of risk-averse executives with those of shareholders. Through a base salary, an annual bonus tied to accounting performance, stock options, and long-term incentive plans (including restricted stock plans and multi-year accounting-based performance plans), shareholders intend to compensate executives for their overinvestment of human capital in a single rm and their undiversied personal wealth portfolios. In studying the nancial crisis, Fahlenbrach and Stulz (2009) conclude that high levels of insider ownership (the classic correction to the principal/agent incentive alignment problem) did not lead the banks to take excessive risk. Bank CEOs suffered large losses during the crisis, indicating that while executives maintained well-aligned equity ownership stakes they may have misunderstood the accretion of risk occurring within the banking system. In contrast, Bebchuk and Spamann (2009) argue that the principalagent conict between bank owners and managers has been effectively externalized to the taxpayers, and that compensation structures strongly determine the risk preferences of managers. Perhaps bank CEOs directed their rms into
1 Joseph Stiglitz, in various interviews with regard to his book, Freefall: America, Free Markets and the Sinking of the World Economy, 2010.

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projects and business that shareholders valued and for which the CEOs were justly compensated. If so, managerial interests were properly aligned with the risk appetites of their common shareholders. One can argue that the truly toxic tranche of large bank equity ownership is implicitly held by the taxpayers in the event of a systemic banking collapse. Jeitschko and Jeung (2005) model the moral hazard of deposit insurance as an agency problem that increases managerial risk-taking incentives. Houston and James (1995) report that bank CEO compensation policies promote risk-taking, as the cash-to-equity compensation ratio in banking and nancial services dominates cash compensation in other industries. As bank risk increases, judged by an increasing proportion of non-interest income sources, the proportion of equity-based CEO compensation also increases (Brewer, Hunter & Jackson, 2004). Bryan, Hwang, and Lilien (2000) claim restricted stock fails to induce risk-averse CEOs to accept riskier projects that should increase value. Clementi and Cooley (2009) nd highly skewed compensation measures, where many CEOs lose money due to the equity-based portion of their wealth, reinforcing the notion that performance incentives have strengthened over time. Douglas (2006) shows that value-maximizing compensation contracts induce bank managers to pursue riskier prots from opaque investments with high levels of information asymmetry. During a nancial crisis, the opacity and complexity of assets become a liability when a rm needs to raise capital. As heated opinions motivate new bank regulation, market discipline advocates fault existing crisisinducing regulatory burdens. Palia (2000) warns that regulated industries attract CEO candidates with lower education levels than deregulated industries. Thompson and Yan (1997) argue that Federal Deposit Insurance Corporation Improvement Act regulation diminishes the effectiveness of private executive compensation contracts. Perhaps the most closely related literature to our study is a recent working paper by Cheng, Hong, and Scheinkman (2009) examining total executive compensation (combining cash and equity pay) as it impacts nancial rm risk. They employ Murphys (2000) theory of irrelevance in the incentive effects of cash and equity compensation. Our research compliments and extends this study by separating the components of bank CEO compensation. We incorporate a practitioner-oriented default risk measure, a list of variables based on risky activities specic to the banking industry, and a view of risk which explicitly isolates the impact of short-term CEO incentives relative to the crisis. Our work utilizes and expands threads on CEO compensation, bank risk and default risk, agency theory, and banking regulation.

3. Hypothesis development Does bank compensation increase bank risk and fuel a short-term bias? Did CEO compensation drive the risky behavior of banks leading to the nancial crisis? We test the hypothesis that CEO compensation motivates bank risk by seeking a signicant correlation between bank risk and compensation structures. We rely on a variety of risk measures used in credit analysis by regulators, banks and industry analysts, and a subset of risky activities specically related to the nancial crisis. We decompose CEO compensation into short-term and long-term components, and connect these to future risky activities undertaken by the bank. Our null hypothesis is that bank CEO compensation has no signicantly positive correlation to risky bank activities. We focus on publicly traded bank holding companies (BHCs) in order to have meaningful comparisons of accounting data between rms; BHCs must le quarterly reports with the Federal Reserve that include accounting and holdings data, including supporting schedules and off balance-sheet items. We expect bonuses to positively correlate with risk due to their explicit short-term performance focus. Salary is expected to be negatively correlated with risk, as undue risk jeopardizes a CEOs salary and continued employment. In optimal contracting theory, xed salaries satisfy the reservation wage, and the bonuses satisfy the incentive compatibility constraint. As both cash components are realized within the year, the comprehensive cash compensation package is expected to correlate positively with a short-term focus and risk-taking, with bonuses dominating salary in inuence. If CEOs did indeed take large risks in pursuit of big bonuses, bonuses should be related positively and strongly to short-term performance and risk-taking.

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Our expectations of long-term incentives are more nuanced. Agency theory predicts that bank risk should be an increasing function of equity holdings, if managers must be induced to take more risk than they would without the incentive alignment offered by ownership (wealth effects from large equity holdings, discussed below, may reduce a CEOs risk appetite). Equity incentives are not meant to promote excessive risk that jeopardizes the rm, though banks may be less bound by this constraint if they exploit the safety net of insured deposits, or reasonably expect that the government will rescue systemically important rms. CEO wealth is largely undiversied in own-rm equity. Vested equity stakes should increase risk aversion via wealth protection effects, while unvested shares and options should raise risk appetite through wealth accumulation effects (Agrawal & Mandelker, 1987). A CEOs ability to sell vested shares may attenuate this bias, but the market signaling effect of large insider sales should dampen levels of CEO equity sales. We expect a negative impact on short-term risk due to vested securities, and a positive impact from unvested shares and options.

4. Data denitions and summary statistics 4.1. Sample Our study requires detailed compensation data for the largest banks in the U.S., those most likely to pose systemic risk. We use Compustats ExecuComp database and searched for CEO compensation data on all rms with SIC codes 60206029, 6080, 6081, 6082, 6090, 6199, 6712, and 6719. FR Y-9C reports from the Chicago Federal Reserve provided bank accounting data. For the primary hypotheses we focus on years 20042008. We use 2-year lags of compensation variables to control for endogeneity between contemporaneous risk and compensation. Our sample size for 2008 (with 2006 compensation variables) is 84.

4.2. Independent variables CEO compensation and control variables CEO compensation variables are scaled by total compensation, which is dened as salary, bonus, all other (perks), total value of restricted stock granted, total value of options granted, and longterm incentive payouts. Option values use the BlackScholesMerton methodology as per ExecuComp. Variables are grouped by short-erm and long-term incentive structure; bonuses are incentives for meeting short- to intermediate-term accounting measures goals, whereas vested shares should align manager and shareholder incentives over the long term. Fig. 1 lists the variables used in our analysis and their expected effects on rm risk. Short-term compensation includes cash compensation components. We include an interactive term, bonus interactive, which is the product of annual salary and bonus gures. We do this to capture any marginal effects of high cash compensation. For example, salary or bonus may not be signicant predictors of bank risk, but the combination (high bonuses in the presence of high salary) may be signicant. Long-term compensation is divided into vested and unvested shares and options. Table 1 reports summary statistics on the independent variables used in the study. Although all of the rms in the study are large banking rms, there is considerable variation in how CEOs are compensated. On one end of the spectrum, salary comprises nearly all of the compensation granted to the CEO, while on the other end bonuses comprise almost 63% of total compensation. Interestingly, relatively few banks award their CEOs bonuses at all; at the 50th percentile no bonuses are paid, and at the 75th percentile, only 5% of the total compensation is in the form of bonuses. Vested long-term cumulative compensation (vested shares and exercisable options) dwarfs the unvested wealth of bank CEOs. At the means, vested shares are 13 times the value of unvested shares, and exercisable options are worth 10 times the amount of un-exercisable options. This could signicantly impact incentive schemas, as CEOs may sell vested shares and exercisable options, reducing the alignment between executive and shareholder interests. Since executives must report sales and exercised options, sending a negative signal to the market, vested equity may actually decrease risk taking as executives keep their shares and attempt to protect their wealth.

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Variable

Description Short term

salary as a percentage of total annual compensation bonus as a percentage of total annual compensation cash compensation as a percentage of total annual compensation interaction term combining effects of bonuses and salary

Expected effect on short term risk level

salary_tc bonus_tc salary_bonus_tc bonus_interactive

+ +/+/-

Long term, current shr_flow_tc opt_flow_tc

value of shares granted in current year as a percentage of total annual compensation value of options granted in current year as a percentage of total annual compensation

+ + + + + +/+/-

Long term, cumulative vested_shr_tc unvested_shr_tc vested_opt_tc unvested_op_tc pct_shr_own total_shr_value

value of vested shares as a percentage of total annual compensation value of unvested shares as a percentage of total annual compensation value of vested options as a percentage of total annual compensation value of unvested options as a percentage of total annual compensation percentage of total outstanding shares of the firm owned by the CEO, excluding options total value of all shares owned, excluding options, as a percentage of total annual compensation

Control variables age tenure ceo_change ln_assets tobin_q

age of the executive number of years as CEO 1 if the firm has a new CEO during the year, 0 otherwise natural log of total firm assets Tobin's Q, a measure of market power as represented by market value vs. book value of assets

Fig. 1. Variable descriptions and expected relations to bank risk.

4.3. Dependent variables: SEER bank risk determinants We rst select dependent variables used in off-site bank surveillance. These variables are taken from Y9-C reports and have been proven to be effective determinants of the probability that a bank will fail within two years (Cole & Gunther, 1995). These risk measures appear in the Federal Reserves System to Estimate Examination Ratings (SEER) early warning model used for off-site surveillance (Gilbert, Meyer, & Vaughan, 2000). We scale these variables by total assets, and group according

J.C. Acrey et al. / Journal of Economics and Business 63 (2011) 456471 Table 1 Summary descriptions of independent variables. Variable Executive compensation Salary tc 2006 Bonus tc 2006 Bonus interactive 2006 Shr ow tc 2006 Opt ow tc 2006 Vested shr tc 2006 Unvested shr tc 2006 Vested opt tc 2006 Unvested opt tc 2006 Control variables Age 2006 Tenure 2006 CEO change 2006 ln assets 2006 Tobin q 2006 N Mean Standard deviation 0.22825 0.14810 0.09360 0.22959 0.22041 25.70625 1.11297 3.36141 0.34754 5.97291 7.68820 0.29373 1.59345 0.06264 25th percentile Median 75th percentile Max

461

84 84 84 84 84 83 84 84 84 85 85 85 85 85

0.33603 0.07999 0.04343 0.17779 0.19165 13.57934 0.53595 2.18078 0.25089 57.22353 9.34118 0.09412 16.74325 1.12465

0.14622 0.00000 0.00000 0.00000 0.03060 1.87406 0.00000 0.20549 0.00000 53.00000 4.00000 0.00000 15.63374 1.08233

0.29640 0.00000 0.00000 0.09584 0.12307 4.29479 0.07704 1.34888 0.10840 58.00000 7.00000 0.00000 16.26343 1.11890

0.47128 0.10770 0.05047 0.26507 0.29171 11.15017 0.67526 2.69428 0.36895 61.00000 14.00000 0.00000 17.73116 1.16456

0.95869 0.62578 0.49335 1.01875 1.25191 145.43938 7.17922 24.87382 1.57585 76.00000 44.00000 1.00000 21.42297 1.33710

Executive compensation data are from Compustat ExecuComp. All compensation variables are normalized by dividing by total compensation (TDC1), dened as salary, bonus, all other, total value of restricted stock grants, total value of option grants, and long term incentive payouts in 2006. Bonus interactive is the product of salary and bonus divided by total compensation. Shr ow and opt ow are the shares and options values, respectively, awarded during the year. Vested/unvested shares/options are the fair values of cumulative past awards of shares and options, either vested or unvested, as of 2006. Option portfolio values are computed using the modied BlackScholesMerton methodology, as per ExecuComp. CEO change is a binary variable taking the value of 1 if the rm has a new CEO during the scal year and 0 otherwise. ln assets is the natural log of rm assets. Tobin q is Tobins Q, a measure of market power wherein market valuation is compared to book value; a number greater than one indicates the market value of the rm is greater than the replacement cost of its assets.

to their predicted impact on bank risk. The rst group represents predicted increases in risk, and includes: DelqLoan30d are a banks interest-accruing loans which are between 30 and 89 days past due; DelqLoan90+d are a banks interest-accruing loans which are at least 90 or more days past due; NonAccruLoan refers to the banks delinquent loans which are not accruing interest; ForclRealEst is the book value of foreclosed real estate; JumboCDs is the value of domestic certicates of deposit, $100,000 or greater in value.

The remaining SEER-based variables are expected to have a negative relation to risk. These variables include: TangibleCapital is the banks equity, less goodwill; OpIncome is net operating income before extraordinary items, less the gain (loss) on sale of securities; LoanLossResrv is the allowance for loan and lease loss reserves; InvSecurities is the book value of investment securities;

We also use a market-based measure of bank default risk called the expected default frequency (EDF), calculated as in Crosbie and Bohn (2003). A banks distance to default is calculated as the difference between the market value of assets and the book value of debt, divided by the volatility of the banks assets. We map the distance measure into a default probability by assuming a normal distribution. EDF increases with asset volatility and decreases with the difference between the market value of assets and the book value of debt. Additionally, we include dependent variables that should be larger for banks that were heavily involved in the risky activities leading up to the nancial crisis. We separate the crisis-centric risk variables from the SEER risk framework variables to avoid contaminating our measures and predicting the last crisis. These variables have not traditionally been measures of bank risk but were proven,

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ex post, to be relevant risk measures. Several of these reporting items were not mandated by the Fed until recently, while new crisis-sensitive variables such as synthetic and other collateralized debt obligations, retained benecial interests in securitizations, and loans pending securitization attracted reporting mandates in 2008. OtherMBS: Other mortgage backed securities are often called private label MBS because they are often comprised of securitized sub-prime mortgages; these securities are not guaranteed by government backed agencies. For this investigation OtherMBS are securities comprised of rst and second liens on one to four family residential properties. %SecuritizInc is net securitization income as a percentage of the banks net income. Non-interest income could diversify bank income streams and decrease risk; alternatively, it been shown to increase bank risk (Stiroh, 2004). We consider securitization income risky in context, due to the prevalence of subprime mortgage securitization. Trading Assets are assets held at fair value with the intention to sell quickly. These include OtherMBS and other securities such as credit default swaps. We include this as a measure of non-traditional banking activity as compared to typical bank assets, loan portfolios. Recourse includes nancial standby letters of credit, performance standby letters of credit, recourse and direct credit substitutes, and other nancial assets sold with recourse. Recourse exposes banks to the risk that securities already sold by the bank will underperform and be put back to the bank. We exclude commercial letters of credit, securities lent, or risk participations in bankers acceptances in order to focus on what was most likely to be shared across the sample during the crisis: recourse on MBS-type securities. Table 2 reports summary statistics of risk variables. By the end of 2008, the mean EDF was greater than 25%. At the 75th quartile the default probability rises to almost 50%. Other mortgage-backed
Table 2 Summary statistics of dependent variables. Variable Bank risk measures DelqLoan30d DelqLoan90d NonAccruLoan ForclRealEst TangibleCapital OpIncome LoanLossResrv InvSecurities JumboCDs EDF Bank risk behaviors OtherMBS Trading Assets %SecuritzInc Recourse N 36 36 36 36 36 36 36 36 36 35 45 85 85 85 Mean 0.01043 0.00404 0.01262 0.00176 0.07446 0.00080 0.01226 0.17962 0.08355 0.25288 0.00086 0.01212 0.02083 0.03797 Standard deviation 0.00685 0.00516 0.00943 0.00166 0.01671 0.01829 0.00565 0.09282 0.03873 0.29844 0.00311 0.04001 0.08133 0.03872 25th percentile 0.00647 0.00098 0.00564 0.00059 0.06273 -0.00905 0.00981 0.11669 0.06234 0.00224 0.00000 0.00000 0.00000 0.01332 Median 0.00995 0.00221 0.01013 0.00143 0.07644 0.00487 0.01172 0.14863 0.07480 0.17171 0.00000 0.00000 0.00000 0.02431 75th percentile 0.01334 0.00420 0.02212 0.00249 0.08475 0.01368 0.01481 0.22280 0.10957 0.49277 0.00003 0.00473 0.00000 0.04713 Max 0.03155 0.02418 0.03396 0.00701 0.10310 0.02500 0.02737 0.44337 0.16700 0.96225 0.01850 0.27061 0.58251 0.19950

Bank risk measure variables are scaled by total value of bank assets as of scal year 2008. Bank risk behavior variables are scaled by the total value of bank assets as of scal year 2006 with the exception of %SecuritizInc which is scaled by net income in 2006. DelqLoan30d and DelqLoan90d are the values of delinquent bank loans with a past-due period of 3089 or 90+ days, respectively, but still accrue interest and are therefore performing. NonAccruLoan is the value of loans that are no longer accruing interest. ForclRealEst is the book value of foreclosed real estate. TangibleCapital is bank equity less goodwill. OpIncome is net income less extraordinary items and gains (losses) on the sale of securities. LoanLossReserv is the value of reserves against losses in loans and leases. InvSecurities is the value of investment securities. JumboCDs is the value of all domestic certicates of deposit greater than $100,000. EDF is expected default frequency. OtherMBS is the value of other or private label mortgage backed securities not guaranteed by government backed agencies. Trading Assets is the value of all marketable securities held for trading purposes, including mortgage backed securities and credit default swaps. %SecuritzInc is the percentage of income resulting from securitization activity. Recourse is the value of guarantees made by the bank to the buyers of securitized products, and includes nancial standby letters of credit, performance standby letters, recourse and direct credit substitutes, and other assets sold with recourse.

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securities comprise a small percentage of total assets, even at the height of their popularity and asset valuations. Almost all banks retained some recourse on their books, but at the 75th percentile is less than 5% of the asset value. Securitization income shows that only a few banks actively pursued securitization income in addition to traditional banking activities. That said, those that did securitize did so aggressively. At the 75th percentile securitization income is negligible but quickly jumps to a maximum of 58% of net income. 5. Methodology We run two sets of regressions, the rst assessing a banks risk using commonly known bank risk factors, while the second set exploits the clarity of hindsight to link executive pay to specic bank activities that contributed to the nancial crisis. All regressions lag compensation variables by two years to address the endogeneity between contemporaneous compensation and bank risk. The two year lag structure allows enough time for compensation policies to affect the risks we investigate. One- and three-year lags were rejected for parsimony, as they yield no substantial improvements in model tness. Our basic model follows: Risk Measuret = + 1 [Compensation Variablest 2 ] + 2 [Control Variablest ] + t We control for the rm-specic characteristics of size and market power with the natural log of total assets and Tobins Q. Larger, more powerful rms are more likely to diversied in their income streams and therefore more likely to weather nancial crises. Conversely, if rms are large enough to pose systemic risk, they might take on more risk if there is an implicit assumption that the government will not allow systemically important rms to collapse. We control for a change in the CEO during the year, as well as the age and tenure of the CEO to measure the effects of experience and distance to retirement. CEOs that are newer to their post and those who are relatively young, and therefore presumed to be further from retirement, may be more likely to decrease short-term risk and focus on long-term incentives. Conversely, elder CEOs would likely experience an increased short-term focus as they approach retirement, as their options and stock grants are largely vested and their wealth is decreasingly tied to the success of the bank. Thus, we predict that bank risk increases with CEO tenure and age. Overcondence and hubris arguments also predict a positive relationship between tenure, age, and risk. We expect both of these factors to compress CEO planning horizons and promote short-term risk-taking activity. The rst set of regressions tests the relationship between bank risk variables used in offsite monitoring programs and CEO compensation incentives. Our second series of regressions uses CEO compensation variables from 2004 to explain crisis-related bank activities in 2006. We use trading assets, OMBS, recourse, and securitization income from 2006, the good times when revenues produced from these risky activities were at their highest levels. Both sets of tests use cross-sectional OLS regressions, with BreushPagan/CookWeisberg tests to check for the presence of heteroskedasticity. When heteroskedasticity is present, we rerun the regressions with standard errors robust to heteroskedasticity. This is often the case with the crisiscentric risk variables of recourse, trading assets, other mortgage backed securities, and securitization income. In most cases the results are unaffected, and when the difference is signicant we report the robust results. 6. Results The rst set of regressions focus on the Federal Reserves System to Estimate Examination Ratings (SEER) bank risk variables. Regressions are expanded to broaden the scope of the investigation each round such that short term, then long term, then all compensation variables are included in the regressions on bank risk. Table 3 reports results of regressions of short-term cash incentives, salary and bonuses, on SEER risk variables. Total cash compensation is not a statistically signicant predictor of risk, though it approaches statistical signicance with regard to decreased tangible capital.

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Table 3 Regressions of total cash compensation on System to Estimate Examination Ratings (SEER) Federal Reserve risk variables. DelqLoan30d Salary bonus tc Age Tenure CEO change ln assets Tobin q R2 N 0.00091 (0.81) 0.00035* (0.07) 0.00040** (0.02) 0.00506 (0.11) 0.00014 (0.84) 0.06223*** (0.00) 0.526 35 DelqLoan90+d 0.00152 (0.64) 0.00029* (0.07) 0.00007 (0.64) 0.00605** (0.03) 0.00071 (0.23) 0.01729 (0.22) 0.407 35 NonAccruLoan 0.00076 (0.88) 0.00053** (0.04) 0.00046* (0.05) 0.00055 (0.90) 0.00132 (0.16) 0.09967*** (0.00) 0.543 35 ForclRealEst 0.00025 (0.84) 0.00005 (0.41) 0.00011** (0.04) 0.00092 (0.35) 0.00010 (0.66) 0.00337 (0.51) 0.211 35 TangibleCapital 0.01813 (0.10) 0.00005 (0.93) 0.00047 (0.33) 0.01015 (0.26) 0.00729*** (0.00) 0.05187 (0.27) 0.372 35 OpIncome 0.00321 (0.75) 0.00016 (0.73) 0.00133*** (0.00) 0.00456 (0.58) 0.00102 (0.58) 0.17931*** (0.00) 0.548 35 LoanLossResrv 0.00052 (0.90) 0.00017 (0.39) 0.00020 (0.27) 0.00139 (0.68) 0.00018 (0.81) 0.03299* (0.06) 0.220 35 InvSecurities 0.01466 (0.82) 0.00618** (0.05) 0.00160 (0.57) 0.02238 (0.67) 0.01536 (0.19) 0.16983 (0.53) 0.295 35 JumboCDs 0.00677 (0.77) 0.00088 (0.43) 0.00345*** (0.00) 0.01622 (0.39) 0.00446 (0.29) 0.11505 (0.25) 0.427 35 EDF J.C. Acrey et al. / Journal of Economics and Business 63 (2011) 456471 0.06270 (0.77) 0.00393 (0.67) 0.01180 (0.17) 0.18582 (0.22) 0.06823 (0.06) 1.78850** (0.03) 0.429 34

Cross-sectional regression of bank risk measures as of scal year 2008 explained by cash compensation and control variables lagged to 2006. DelqLoan30d and DelqLoan90d are the values of delinquent bank loans with a past-due period of 3089 or greater than 90 days, respectively, but still accrue interest and are therefore performing. NonAccruLoan is the value of loans that are no longer accruing interest. ForclRealEst is the book value of foreclosed real estate. TangibleCapital is bank equity less goodwill. OpIncome is net income less extraordinary items and gains (losses) on the sale of securities. LoanLossReserv is the value of reserves against losses in loans and leases. InvSecurities is the value of investment securities. JumboCDs is the value of all domestic certicates of deposit greater than $100,000. EDF is expected default frequency. Salary bonus tc is the sum of cash salary and bonus compensation as a percentage of total compensation. CEO change is a binary variable taking the value of 1 if the rm has a new CEO during the scal year and 0 otherwise. ln assets is the natural log of rm assets. Tobin q is Tobins Q, a measure of market power wherein market valuation is compared to book value; a number greater than one indicates the market value of the rm is greater than the replacement cost of its assets. Numbers in parentheses are p-values. Values in bold are statistically signicant, with the signicance level indicated with asterisks.
* ** ***

Statistical signicance at the 10% level. Statistical signicance at the 5% level. Statistical signicance at the 1% level.

Table 4 Cash compensation, CEO control, and SEER risk variables. DelqLoan30d Salary bonus tc Pct shr own Age Tenure CEO change ln assets Tobin q R2 N 0.00094 (0.81) 0.02135 (0.86) 0.00036* (0.09) 0.00038* (0.06) 0.00498 (0.13) 0.00016 (0.82) 0.06183*** (0.00) 0.527 35 DelqLoan90+d 0.00145 (0.66) 0.05519 (0.60) 0.00034* (0.07) 0.00002 (0.89) 0.00584** (0.04) 0.00076 (0.21) 0.01626 (0.26) 0.413 35 NonAccruLoan 0.00069 (0.90) 0.05690 (0.73) 0.00049* (0.09) 0.00050* (0.07) 0.00077 (0.86) 0.00138 (0.16) 0.10074*** (0.00) 0.545 35 ForclRealEst 0.00029 (0.81) 0.03682 (0.34) 0.00008 (0.24) 0.00008 (0.18) 0.00078 (0.44) 0.00006 (0.79) 0.00268 (0.60) 0.238 35 TangibleCapital 0.01929 (0.05) 0.88098*** (0.01) 0.00073 (0.17) 0.00023 (0.64) 0.00677 (0.40) 0.00819*** (0.00) 0.06834 (0.11) 0.523 35
*

OpIncome 0.00293 (0.77) 0.21324 (0.51) 0.00033 (0.55) 0.00116** (0.03) 0.00538 (0.52) 0.00123 (0.51) 0.17532*** (0.00) 0.556 35

LoanLossResrv 0.00030 (0.94) 0.16328 (0.20) 0.00004 (0.85) 0.00033 (0.11) 0.00076 (0.82) 0.00001 (0.99) 0.03604** (0.04) 0.266 35

InvSecurities 0.00997 (0.87) 3.54320* (0.07) 0.00344 (0.30) 0.00441 (0.16) 0.03601 (0.48) 0.01175 (0.30) 0.23609 (0.37) 0.375 35

JumboCDs 0.00617 (0.79) 0.45630 (0.54) 0.00124 (0.33) 0.00381*** (0.00) 0.01447 (0.45) 0.00492 (0.26) 0.12359 (0.22) 0.435 35

EDF 0.08680 (0.68) 5.89345 (0.32) 0.00885 (0.39) 0.00676 (0.49) 0.20991 (0.18) 0.07570** (0.04) 1.66225** (0.05) 0.450 34 J.C. Acrey et al. / Journal of Economics and Business 63 (2011) 456471

Cross sectional regression of bank risk measures as of scal year 2008, cash compensation and CEO bank ownership lagged to 2006. DelqLoan30d and DelqLoan90d are the values of delinquent bank loans with a past-due period of 3089 or greater than 90 days, respectively, but still accrue interest and are therefore performing. NonAccruLoan is the value of loans that are no longer accruing interest. ForclRealEst is the book value of foreclosed real estate. TangibleCapital is bank equity less goodwill. OpIncome is net income less extraordinary items and gains (losses) on the sale of securities. LoanLossReserv is the value of reserves against losses in loans and leases. InvSecurities is the value of investment securities. JumboCDs is the value of all domestic certicates of deposit greater than $100,000. EDF is expected default frequency. Salary bonus tc is the sum of cash salary and bonus compensation as a percentage of total compensation. Pct shr own is the percentage of outstanding rm shares owned by the CEO excluding shares represented by options holdings. CEO change is a binary variable taking the value of 1 if the rm has a new CEO during the scal year and 0 otherwise. ln assets is the natural log of rm assets. Tobin q is Tobins Q, a measure of market power wherein market valuation is compared to book value; a number greater than one indicates the market value of the rm is greater than the replacement cost of its assets. Numbers in parentheses are p-values. Values in bold are statistically signicant, with the signicance level indicated with asterisks.
* ** ***

Statistical signicance at the 10% level. Statistical signicance at the 5% level. Statistical signicance at the 1% level.

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Table 4 repeats the previous regression but includes a variable measuring the percentage of outstanding shares owned by the CEO in order to capture the effects of long-term cumulative equity compensation on bank risk. Interestingly, short-term cash compensation becomes negative and signicant with regard to tangible capital with the addition of CEO ownership, which is also negative and highly signicant to tangible capital at the 1% level. Also, rms with high CEO ownership levels also show higher, marginally signicant levels of investment securities relative to all assets. A 1% increase in CEO ownership decreases tangible capital by 0.88% and increases the percentage of investment securities to total assets by 3.54%. Table 5 reports regression results of cash compensation and the dollar value of shares owned by the CEO regressed on SEER bank risk variables. Cash compensation loses signicance with regard to decreases in tangible capital but maintains the negative relationship. Higher CEO equity value retains the negative and statistically signicant relationship to tangible capital and also shows a marginally signicant relationship to increased expected default frequency. The compensation variables in our investigations are consistently overshadowed by the narrative generated by our control variables. We controlled for the age and tenure of the CEO, whether there was a change in the rm CEO that year, and for the size and market power of the rm. CEO age and tenure are positively and consistently signicant with regard to non-accruing and delinquent loans and negatively signicant with regard to operating income. These ndings provide evidence that the older the CEO and the longer he or she has been at the rm, presumably then the closer to retirement and the more risky the bank. This provides some evidence of a short-term orientation on the part of older, tenured bank executives. We also nd that the size of the rm is positively and signicantly correlated with increased expected default frequency at the 5% level. This suggests that larger rms are more likely to default, providing evidence supporting the argument that insured deposits and, perhaps, the assumption on the part of bank executives that the largest rms are too big to fail, encourage moral hazard and the exploitation of the government safety net. However, market power as represented by Tobins Q is negatively and signicantly correlated to bank risk as represented by delinquent and nonaccruing loans and expected frequency of default and positively correlated with operating income, all at the 1% level. Table 6 broadens the investigation of CEO compensation and SEER risk variables by breaking compensation into its myriad components. Expected default frequency (EDF) is a measure of the probability of default within the next two years. It is therefore a short term risk metric whereas increases in EDF point to an increase in short-term risk. High salaries relative to total compensation, as expected, increase operating income and signicantly decrease EDF at the 5% level. High bonuses, by themselves, are also shown to decrease EDF. However, high salaries in the presence of high bonuses, as represented by the interaction term, are positively and signicantly correlated with expected default frequency at the 5% level. High bonuses, when coupled with high salaries, show a marked turn to short term risk taking; a 1% increase in this interaction term increases EDF by 3.37%, even though high salaries and high bonuses, independent of one another, show decreases in short term risk taking. A 1% increase in salary (bonus) as a percentage of total compensation decreases EDF by 0.46% (2.10%). Thus it is not bonuses per se that are the problem, but the combination of high salary and bonuses that may be cause for concern. Both share grants and vested shares are positively correlated with short term bank risk at the 10 and 5% levels, respectively, supporting the ndings of Fahlenbrach and Stulz (2009) that CEO incentives are properly aligned with shareholders. A 1% increase in share grants or vested shares increases EDF by 0.43% and 0.01%, respectively. Options, both vested and unvested, are marginally but negatively correlated with short term risk, supporting the argument that option compensation properly provides long term incentives to managers. Table 7 reports results from the second vein of our investigation, where we relate compensation to the banking activities proven ex post to be contributors to the nancial crisis. Compensation variables from 2004 are regressed on other mortgage backed securities, trading assets, net securitization income, and recourse variables in 2006 to capture any relationship between compensation and crisis-specic activity prior to the collapse of the real estate market, thus, at the height of these activities. We nd no signicant relationship between bonuses and risk, though the interaction between high bonuses and high salaries is a marginally signicant predictor of higher trading assets relative to total bank

Table 5 Cash compensation, equity value, and SEER risk variables. DelqLoan30d Salary bonus tc Total shr value Age Tenure CEO change ln assets Tobin q R2 N 0.00036 (0.93) 0.00004 (0.61) 0.00039* (0.06) 0.00034* (0.09) 0.00503 (0.12) 0.00017 (0.81) 0.06745*** (0.00) 0.557 34 DelqLoan90+d 0.00184 (0.60) 0.00000 (0.95) 0.00029* (0.10) 0.00007 (0.69) 0.00604** (0.03) 0.00073 (0.23) 0.01968 (0.19) 0.413 34 NonAccruLoan 0.00056 (0.92) 0.00005 (0.63) 0.00059** (0.04) 0.00039 (0.15) 0.00051 (0.90) 0.00130 (0.18) 0.10449*** (0.00) 0.559 34 ForclRealEst 0.00011 (0.93) 0.00003 (0.29) 0.00007 (0.25) 0.00008 (0.20) 0.00091 (0.37) 0.00011 (0.63) 0.00371 (0.49) 0.245 34 TangibleCapital 0.01390 (0.17) 0.00056** (0.01) 0.00053 (0.30) 0.00016 (0.74) 0.00998 (0.21) 0.00687*** (0.00) 0.06485 (0.14) 0.516 34 OpIncome 0.00493 (0.65) 0.00016 (0.46) 0.00031 (0.56) 0.00115** (0.03) 0.00462 (0.58) 0.00093 (0.62) 0.17881*** (0.00) 0.544 34 LoanLossResrv 0.00011 (0.98) 0.00002 (0.83) 0.00016 (0.46) 0.00022 (0.30) 0.00139 (0.68) 0.00023 (0.76) 0.03701* (0.05) 0.243 34 InvSecurities 0.01853 (0.78) 0.00121 (0.37) 0.00521 (0.12) 0.00292 (0.37) 0.02265 (0.67) 0.01663 (0.16) 0.23299 (0.41) 0.338 34 JumboCDs 0.01141 (0.64) 0.00015 (0.77) 0.00105 (0.39) 0.00365*** (0.00) 0.01611 (0.41) 0.00457 (0.29) 0.09560 (0.36) 0.440 34 EDF 0.05830 (0.78) 0.00735* (0.08) 0.01227 (0.23) 0.00153 (0.88) 0.19537 (0.19) 0.07115** (0.04) 1.70726** (0.04) 0.483 33 J.C. Acrey et al. / Journal of Economics and Business 63 (2011) 456471

Cross sectional regression of bank risk measures as of scal year 2008, cash compensation and CEO bank ownership lagged to 2006. DelqLoan30d and DelqLoan90d are the values of delinquent bank loans with a past-due period of 30-89 or greater than 90 days, respectively, but still accrue interest and are therefore performing. NonAccruLoan is the value of loans that are no longer accruing interest. ForclRealEst is the book value of foreclosed real estate. TangibleCapital is bank equity less goodwill. OpIncome is net income less extraordinary items and gains (losses) on the sale of securities. LoanLossReserv is the value of reserves against losses in loans and leases. InvSecurities is the value of investment securities. JumboCDs is the value of all domestic certicates of deposit greater than $100,000. EDF is expected default frequency. Salary bonus tc is the sum of cash salary and bonus compensation as a percentage of total compensation. Total shr value is the value of the CEO equity portfolio as a percentage of total current year compensation. CEO change is a binary variable taking the value of 1 if the rm has a new CEO during the scal year and 0 otherwise. ln assets is the natural log of rm assets. Tobin q is Tobins Q, a measure of market power wherein market valuation is compared to book value; a number greater than one indicates the market value of the rm is greater than the replacement cost of its assets. Numbers in parentheses are p-values. Values in bold are statistically signicant, with the signicance level indicated with asterisks.
* ** ***

Statistical signicance at the 10% level. Statistical signicance at the 5% level. Statistical signicance at the 1% level.

467

468

Table 6 Short and long term compensation components and SEER risk variables.
DelqLoan30d Salary tc Bonus tc Bonus interactive Shr ow tc Opt ow tc Vested shr tc Unvested shr tc Vested opt tc Unvested opt tc Age Tenure CEO change ln assets Tobin q R2 N 0.00176 (0.77) 0.03778 (0.20) 0.06191 (0.13) 0.01083 (0.12) 0.00394 (0.53) 0.00004 (0.71) 0.00196 (0.20) 0.00002 (0.98) 0.00064 (0.86) 0.00023 (0.39) 0.00061** (0.04) 0.00768* (0.06) 0.00115 (0.33) 0.07740*** (0.00) 0.656 34 DelqLoan90+d 0.00280 (0.57) 0.04146* (0.08) 0.05732* (0.09) 0.00440 (0.42) 0.00886* (0.09) 0.00005 (0.53) 0.00106 (0.38) 0.00097 (0.15) 0.00174 (0.56) 0.00029 (0.18) 0.00016 (0.49) 0.00490 (0.14) 0.00158 (0.10) 0.01619 (0.33) 0.609 34 NonAccruLoan 0.00571 (0.52) 0.00469 (0.91) 0.01146 (0.85) 0.00024 (0.98) 0.00620 (0.50) 0.00008 (0.60) 0.00146 (0.51) 0.00072 (0.55) 0.00369 (0.50) 0.00051 (0.20) 0.00028 (0.50) 0.00075 (0.90) 0.00219 (0.21) 0.10872*** (0.00) 0.605 34 ForclRealEst 0.00158 (0.37) 0.00530 (0.52) 0.00729 (0.53) 0.00062 (0.75) 0.00280 (0.13) 0.00000 (0.92) 0.00091** (0.05) 0.00031 (0.19) 0.00126 (0.24) 0.00003 (0.65) 0.00017** (0.05) 0.00101 (0.38) 0.00027 (0.42) 0.01074* (0.08) 0.516 34 TangibleCapital 0.02134 (0.17) 0.00012 (1.00) 0.00841 (0.93) 0.02386 (0.18) 0.02474 (0.13) 0.00032 (0.25) 0.00673* (0.09) 0.00050 (0.81) 0.00652 (0.49) 0.00044 (0.51) 0.00064 (0.37) 0.01854* (0.08) 0.00825** (0.01) 0.04656 (0.38) 0.619 34 OpIncome 0.02697* (0.05) 0.10559 (0.10) 0.16648* (0.07) 0.01332 (0.37) 0.00170 (0.90) 0.00023 (0.34) 0.00217 (0.51) 0.00030 (0.86) 0.02087** (0.02) 0.00055 (0.33) 0.00108* (0.09) 0.01466 (0.10) 0.00240 (0.35) 0.15430*** (0.00) 0.767 34 LoanLossResrv 0.00100 (0.88) 0.01220 (0.70) 0.01302 (0.77) 0.00113 (0.88) 0.00672 (0.34) 0.00004 (0.74) 0.00056 (0.74) 0.00100 (0.28) 0.00597 (0.16) 0.00002 (0.93) 0.00025 (0.43) 0.00125 (0.78) 0.00003 (0.98) 0.04374* (0.07) 0.367 34 InvSecurities 0.01597 (0.87) 0.55913 (0.24) 0.63687 (0.33) 0.11470 (0.30) 0.03795 (0.71) 0.00269 (0.14) 0.00603 (0.80) 0.02567* (0.06) 0.04153 (0.49) 0.00162 (0.70) 0.00586 (0.21) 0.03353 (0.60) 0.01916 (0.31) 0.37534 (0.27) 0.512 34 JumboCDs 0.02763 (0.38) 0.07369 (0.62) 0.02249 (0.91) 0.00728 (0.84) 0.10940*** (0.00) 0.00107* (0.07) 0.01759** (0.03) 0.00420 (0.32) 0.02879 (0.14) 0.00162 (0.23) 0.00628*** (0.00) 0.00544 (0.79) 0.00186 (0.76) 0.13282 (0.22) 0.695 34 EDF 0.46050** (0.04) 2.10269* (0.09) 3.37267*** (0.05) 0.43255* (0.08) 0.07743 (0.69) 0.00933** (0.02) 0.05538 (0.28) 0.06584* (0.06) 0.22460* (0.07) 0.02340*** (0.01) 0.00370 (0.72) 0.25748** (0.05) 0.04642 (0.31) 1.01305 (0.13) 0.823 33

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Dependent variables are 2008 bank risk measures. DelqLoan30d and DelqLoan90d are delinquent, interest-accruing bank loans 3089 or 90 days + days past due. NonAccruLoan are delinquent with no interest accrual. ForclRealEst is the book value of foreclosed real estate. TangibleCapital is bank equity less goodwill. OpIncome is net income less extraordinary items and gain/loss on sale of securities. LoanLossReserv is reserve against loan and lease losses. InvSecurities is investment securities. JumboCDs are domestic CDs ($100,000+). EDF is expected default frequency. Independent variables detail 2006 compensation and are normalized by dividing by total compensation (TDC1). Bonus interactive is the product of salary and bonus. Shr ow and opt ow are shares and options awarded during the year. Vested/unvested shares/options are the fair values of cumulative past awards of shares and options as of 2006. Option portfolio values are computed using the modied BlackScholesMerton methodology as per ExecuComp. CEO change is a binary variable = 1 if the rm has a new CEO in the scal year and 0 otherwise. ln assets is the natural log of assets. Tobin q is Tobins Q, wherein market valuation is compared to book value. Numbers in parentheses are p-values. Values in bold are statistically signicant, with the signicance level indicated with asterisks. * Statistical signicance at the 10% level.
** ***

Statistical signicance at the 5% level. Statistical signicance at the 1% level.

J.C. Acrey et al. / Journal of Economics and Business 63 (2011) 456471 Table 7 Short and long term compensation components and crisis-specic bank risk behaviors. OtherMBS 2006 Salary tc 2004 Bonus tc 2004 Bonus interactive 2004 Shr ow tc 2004 Opt ow tc 2004 Vested shr tc 2004 Unvested shr tc 2004 Vested opt tc 2004 Unvested opt tc 2004 Age 2004 Tenure 2004 CEO change 2004 ln assets 2004 tobin q 2004 R2 N 0.00776 (0.22) 0.00024 (0.99) 0.00632 (0.68) 0.00931 (0.13) 0.00926 (0.15) 0.00001 (0.80) 0.00052 (0.38) 0.00004 (0.83) 0.00011 (0.80) 0.00005 (0.73) 0.00006 (0.49) 0.00909*** (0.00) 0.00032 (0.57) 0.00898 (0.43) 0.541 38 Trading Assets 2006 0.02937 (0.48) 0.15885 (0.12) 0.33058** (0.02) 0.03671 (0.41) 0.02728 (0.50) 0.00002 (0.89) 0.00353 (0.37) 0.00014 (0.92) 0.00012 (0.96) 0.00067 (0.55) 0.00005 (0.95) 0.02433 (0.27) 0.00967** (0.04) 0.15527* (0.08) 0.601 61 Net sec income 2006 0.01364 (0.89) 0.29831 (0.24) 0.52337 (0.12) 0.01138 (0.92) 0.09744 (0.34) 0.00131*** (0.00) 0.00248 (0.80) 0.00876** (0.02) 0.00066 (0.91) 0.00585** (0.04) 0.00041 (0.82) 0.02235 (0.68) 0.00239 (0.84) 0.38456* (0.08) 0.411 61

469

Recourse 2006 0.04799 (0.28) 0.04258 (0.69) 0.02492 (0.86) 0.02614 (0.58) 0.02962 (0.49) 0.00005 (0.76) 0.00560 (0.19) 0.00087 (0.56) 0.00209 (0.40) 0.00068 (0.56) 0.00103 (0.19) 0.03704 (0.12) 0.01410*** (0.01) 0.03816 (0.68) 0.383 61

The dependent variables are bank risk behaviors just before the crisis and presumably at relative high points, in 2006. The independent variables are CEO compensation separated into their components in 2004 together with the vector of control variables. OtherMBS is the value of other or private label mortgage backed securities not guaranteed by government backed agencies. Trading Assets is the value of all marketable securities held for trading purposes including mortgage backed securities and credit default swaps. %SecuritzInc is the percentage of income resulting from securitization activity. Recourse is the value of guarantees made by the bank to the buyers of securitized products and includes nancial standby letters of credit, performance standby letters, recourse and direct credit substitutes, and other assets sold with recourse. Executive compensation data are from Compustat ExecuComp. All compensation variables are normalized by dividing by total compensation (TDC1), dened as salary, bonus, all other, total value of restricted stock grants, total value of option grants, and long term incentive payouts in 2004. Bonus interactive is the product of salary and bonus divided by total compensation. Shr ow and opt ow are the shares and options values, respectively, awarded during the year. Vested/unvested shares/options are the fair values of cumulative past awards of shares and options, either vested or unvested, as of 2006. Option portfolio values are computed using the modied BlackScholesMerton methodology as per ExecuComp. CEO change is a binary variable taking the value of 1 if the rm has a new CEO during the scal year and 0 otherwise. ln assets is the natural log of rm assets. Tobin q is Tobins Q, a measure of market power wherein market valuation is compared to book value; a number greater than one indicates the market value of the rm is greater than the replacement cost of its assets. Numbers in parentheses are p-values. Values in bold are statistically signicant, with the signicance level indicated with asterisks.
* ** ***

Statistical signicance at the 10% level. Statistical signicance at the 5% level. Statistical signicance at the 1% level.

assets. Vested shares are positively and signicantly correlated with securitization income at the 1% level, though vested options are negatively correlated with securitization income at the 5% level. Not surprisingly, larger rms were more likely to have higher levels of trading assets and to hold recourse on their books at the 5 and 1% levels, respectively. Once again, however, rms with more market power were marginally less likely to have higher percentages of trading assets and securitization income.

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The negative relationship between high market power as represented by Tobins Q and bank EDF, SEER risk variables, and crisis specic measures of risk is somewhat puzzling. In short, Tobins Q measures how much the market values a banks assets relative to the replacement cost of those assets. One might think that the market was especially valuing those activities that compounded the crisis, for example the securitization of mortgage backed securities, yet our evidence suggests that this is not the case even pre-crisis. This nding bolsters the argument that the market more often than not properly assigns value to rm shares, regardless of hype or the possibility of asset bubbles. 7. Conclusion The nancial crisis and subsequent taxpayer-funded bank bailouts fueled public outrage at bank CEO compensation incentives. Bankers were handsomely compensated despite presiding over a systemic banking crisis. Public demands to punish the guilty and x the system were clearly heard in Washington. Yet, academic research has yet to conclusively tie CEO pay bank risk. We examine the links between short-term CEO compensation practices and bank risk during the nancial crisis. We nd little evidence that bonuses create perverse incentives to increase risk-taking. Un-exercisable options seem to mitigate bank risk, a nding conicting with consensus and extant literature. CEO tenure, however, seems to both increase risky activities and decrease tangible capital and net income. We conclude that bonuses and options did not seem to increase risk, and they may have even dampened some of the socially undesirable, high-risk activities of banks. Thus, we advocate caution; further research on banking incentives is needed before we x what may not be broken. Acknowledgements We are grateful to FISS 2010 participants at the University of Victoria, BC, Tim Yeager, and an anonymous reviewer for helpful comments and suggestions. References
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