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A Theory of Bank Regulation and Management Compensation

Kose John¹; Anthony Saunders¹; Lemma W. Senbet²

¹ New York University · ² University of Maryland, College Park

We show that concentrating bank regulation on bank capital ratios may be ineffective in controlling risk taking. We propose, instead, a more direct mechanism of influencing bank risk-taking incentives, in which the FDIC insurance premium scheme incorporates incentive features of top-management compensation. With this scheme, we show that bank owners choose an optimal management compensation structure that induces first-best value-maximizing investment choices by a bank's management. We explicitly characterize the parameters of the optimal management compensation structure and the fairly priced FDIC insurance premium in the presence of a single or multiple sources of agency problems.

DOI

10.1093/rfs/13.1.95

Volume

13 (1)

Pages

95-125

Language

en

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