A New Look at Regulating Bankers’ Remuneration

Abstract

Manuscript Type: ConceptualResearch Questions/Issues: Executive remuneration, whether as a tool for resolving agency problems or as a sign of them, has been discussed in the literature for decades. The discussion, however, has been focused on non-financial firms, and bankers' remuneration, particularly in the context of corporate governance, has been overlooked until recently. However, following the financial crisis, regulators have begun intervening into banking boards' responsibilities, including remuneration. This raises numerous questions, in particular, how far the existing non-financial literature applies to banks, and if not, why and how this impacts on appropriate corporate governance in banking, and what challenges this brings? Research Findings/Insights: The paper argues that due to numerous externalities, notably the interconnectivity and systemic risk of the banking sector, a traditional approach to remuneration based on resolving the principal-agent conflict is inappropriate. Active involvement of regulators is needed to balance the short-term performance of the banking sector with the long-term needs of society. This, however, means that remuneration and corporate governance of banks is no longer an individual bank issue but is a national and probably an international phenomenon. In some cases this may require fundamental changes to the national governance structure, culture, and practices. Theoretical/Academic Implications: The analysis questions the suitability of the common idea of assessing corporate governance in banks in the same way as is done for non-financial institutions. Given that several traditional non-financial board responsibilities have been partially passed over to regulators in the banking sector, a new theoretical model of corporate governance is needed for banks. The paper examines relational contracts (echoed to some extent in stewardship, stakeholder, and network theories), and argues that these cannot be expected to be successful in the banking environment. Practitioner/Policy Implications: The paper highlights the importance of tying the corporate governance of banks with other regulatory measures employed to restrict risk taking. It also stresses the need for harmonization of corporate governance metrics for the banking sector at a national/international level.

Advancing the Corporate Governance Research Agenda

“…Fifth, the governance of banks, and financial institutions more generally, should also be analyzed within a framework that goes beyond the "traditional" principal-agent conflict. In particular, the "specialness" of banks, as analytically discussed by John et al (2016), Zalewska (2016), and Srivastav and Hagendorff (2016) in this special issue, requires an analytical framework that does not focus exclusively on protecting the interests of equity claimants but also expands to incorporating non-shareholder constituencies' interests such as depositors and the society-at-large. In the presence of potentially conflicting interests among heterogeneous constituents, the effectiveness of traditional governance mechanisms is also limited for the case of banks (see Grove, Patelli, Victoravich, & Xu, 2011;Leventis, Dimitropoulos, & Owusu-Ansah, 2013).…”

Corporate Governance in Banks

“…Most of the empirical research focuses on the consequences of high‐powered incentive managerial contracts such as bonus pay and option contracts. Specifically, the idea of more closely aligning CEO pay with stockholder objectives through pay‐performance sensitivity contracts has been one of the most popular governance practices (Becht et al, ; (Cuñat & Guadalupe, ) Zalewska, ). By making managers’ compensation dependent on firm performance, shareholders can provide incentives, pushing managers to make decisions in the shareholders’ best interest.…”

The impact of executive remuneration on risk-taking in the banking industry

“…Their roles in supporting and ensuring the economic development of countries are essential and, therefore, when the banking sector experiences difficulties, the whole of society bears the consequences. This was exactly the case in 2007, when world financial markets were in the midst of a recession termed the worst since the Great Depression of 1929 (Zalewska, 2015).…”

“…Executive remuneration has frequently been addressed by regulators and other policy-making bodies, with the majority of the literature focusing on the corporate governance structure of non-financial institutions. However, the credit crisis of 2007-2009 emphasized the importance of the financial sector, as well as the resulting consequences should it not adhere to current governance practices (Zalewska, 2015).…”

“…There are numerous different arguments as to why the principle-agent theory should not be utilized in the banking sector, hence, variable remuneration has been proposed and implemented as a possible solution or mitigation technique. Zalewska (2015) argued that when discussing remuneration structures as a mechanism to resolve issues that arise from the separation of ownership and control, it is implicitly assumed that an institution is equity-financed and does not have any social or broadeconomy links and obligations. The banking sector does not comply with this standard approach.…”