Earnings Growth Pressure, Compensation Incentives, and Bank Loan Quality

• In Event: Banking

Abstract

In the aftermath of the financial crisis, bankers, regulators, lawmakers, and the press have claimed that pressure to grow earnings led banks to originate lower quality loans that subsequently experienced high default rates. Poor incentives for bank executives allegedly contributed to this pressure. Using a sample of 313 bank holding companies from 2001 to 2009, we find a significant positive association between future loan defaults and the pressure banks faced from capital markets to grow earnings. Earnings growth pressures are positively associated not only with lower quality on-balance sheet loans but also with loans originated for sale or securitization, which prior work shows are linked to low quality lending. Interestingly, we find no evidence that heightened equity incentives or bonus pay for bank CEOs is linked to higher loan defaults. In fact, we find some evidence these compensation features help mitigate the effect of earnings growth pressure on loan quality. Our study contributes to the literature examining factors associated with the dramatic collapse of the U.S. banking industry during the financial crisis.

Authors

• Christopher G Yust, The University of Texas at Austin

• John M. McInnis, The University of Texas at Austin

• Shuping Chen, The University of Texas at Austin