Fixing bankers’ pay: punish bad risk management, not bad risk outcomes

Misa Tanaka and John Thanassoulis.

Post-crisis, a number of jurisdictions have introduced remuneration regulations in order to reduce bankers’ incentives to take excessive risks.  The UK is pioneering the use of bonus clawbacks under which bankers are asked to pay back their bonuses if certain circumstances materialise at a future date.  In our latest paper, we show that clawback can encourage better incentives as long as bankers believe that they will be held liable for failures of risk management, and not simply for poor outcomes.  Having a transparent mechanism in place to apply clawbacks is therefore critical.  If bankers fear that clawback will be wielded too generally upon bad business outcomes, then it could end up making them excessively risk averse.

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