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Effects of incentive pay on systemic risk: evidence from CEO compensation and CoVar

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Abstract

We examine the role of chief executive officers’ (CEO) pay in contribution to systemic risk in the USA. In particular, by extending the CoVar model of Adrian and Brunnermeier (Am Econ Rev 106(7):1705–1741, 2016), we document that the systemic risk measure of dollar delta CoVar is positively influenced by CEO pay. Differentiation between the types of CEO pay incentives suggests that bonus and option awards comprise major contribution to systemic risk. It follows that governance measures that are aimed at systemic risk management can benefit from distinguishing between short-term and long-term CEO incentives.

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Notes

  1. \(\Delta \)CoVar measures the change in the value at risk of the whole financial system conditional on the state of distress of financial firm relative to the median state of the firm. Value at risk (VaR) is a common method that measures loss associated with the 1–5% chance occurring events on financial markets (Kupiec 1998; Adrian and Brunnermeier 2016).

  2. Dollar \(\Delta \)CoVar, \(\Delta \mathrm{CoVar}^{\$}\), is a measure of systemic risk, reflecting the size of a financial firm and is calculated as the size of a firm times the \(\Delta \)CoVar, that is the change in the value at risk of a financial system conditional on a difference in the state of the firm relative to its median state (Adrian and Brunnermeier 2016).

  3. This measure of bonus/salary follows Fahlenbrach and Stulz (2011).

  4. Examples of restrictions include a bonus penalty for missing the capital requirements https://www.federalreserve.gov/reportforms/formsreview/BaselIII_20131011_ffr.pdf.

  5. Acharya et al. (2016) review similar measures of systemic risk by Billio et al. (2012), De Jonghe (2010), etc.

  6. 0.0027=0.0004\(^{*}\)6.77.

  7. The changes evolved post-crisis and included disclosure of any pay provisions leading to a substantial financial loss, as regulated by Dodd–Frank Wall Street Reform Murphy 2013 and bonus penalties for missing regulatory capital adequacy requirements https://www.federalreserve.gov/reportforms/formsreview/BaselIII_20131011_ffr.pdf.

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Authors and Affiliations

  1. Brisbane, Australia

    Natalya Zelenyuk

  2. UQ Business School, University of Queensland, 305 Colin Clark Building (39), St Lucia, QLD, 4072, Australia

    Robert Faff

  3. Bond Business School, Bond University, Gold Coast, 4229, Australia

    Robert Faff

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  1. Natalya Zelenyuk
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  2. Robert Faff
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We are grateful to the editor, anonymous referee, Ying Wu (discussant) and participants of the 95th Western Economic Association International Conference.

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Zelenyuk, N., Faff, R. Effects of incentive pay on systemic risk: evidence from CEO compensation and CoVar. Empir Econ 63, 3289–3311 (2022). https://doi.org/10.1007/s00181-022-02236-2

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