Regulation of Compensation

• In Event: Incentives and Performance Evaluation

Abstract

This paper studies the consequences of regulating executive compensation at financial institutions. We use the introduction of the UK Remuneration Code and the EU bonus cap regulation to examine changes in compensation practices by financial institutions and related consequences. Our analysis indicates that while the initial reaction to the Remuneration Code was positive, the stock market reacted negatively to the EU bonus cap regulation, suggesting that equity market investors perceive at least some costs from regulating executive compensation. We also find that, in line with the regulation, UK banks defer more bonuses and reduce risk. However, when compared to their US counterparts and other UK firms, UK banks also experience higher executive turnover. Finally, we find that compared to other UK firms, UK banks' compensation contracts become more complex after the regulation. Our findings, therefore, indicate that while regulation may have had the desired effect, it may also have given rise to some unintended costs as well.

Authors

• Anya V Kleymenova, University of Chicago Booth School of Business

• Irem Tuna, London Business School