The Relationship Between Executive Compensation And Bank Risk:an Empirical Study On China’s Listed Banks

Countries hit by the recent financial crisis all made self-examination on their compensation systems, and issued a series of regulatory measures wich attempts to link risk factors to compensation in financial institution. At present, governments and academia also take the problem of executive compensation of financial instituton as an important aspect to improve the corporate risk management, and make careful study on it. The traditional research concerne about the performance effects on executive compensation, while ignoring the relationship between bank risk and executive compensation, assuming that bank executives are risk averse. After the recent financial crisis, however, short-sighted theory assuming that bank executives in some cases will be of risk preferences has been widely used to explain the financial crisis.This paper takes into account both the principal-agent theory which assumes that the bank executives are risk averse, and the short-sighted theory assumes that bank executives are risk preference. We assume that the bank shareholders allocate appropriate level of risk to banks through exective compensation. First, because the risk of human capital of the bank executives are difficult to disperse, to encourage bank executives taking moderate risk, banks’shareholders will give executives risk allowance, then the salary will increased with the risk; But with the increased risk, bankruptcy risk thus also increased, shareholders have to require the bank executives to carry out appropriate risk management, thus the executive compensation will not indefinitely increase. Shareholders will take the initiative to limit the growth of executive compensation and the growth speed of compensation will slowing down with the bank risk increase, that is, an inverted U-shaped curve relationship exisits between the bank risk and executive compensation.In this paper, the 14 listed banks are concluded in the sample to test the relationship between executive compensation and bank risk. Non-systematic risk of bank stocks, the leverage ratio, capital adequacy ratio and non-performing loan ratio are choosed as indicators of bank risk. The bank performance and the banking sector are set as control variables in the empirical models to test the relationship between bank executive compensation and bank risk. The following conclusions can be drawn from the empirical results:(1) the correlation between listed bank executive compensation and non-systematic risk of bank stocks, leverage ratio and non-performing loan ratio does not exist, nor is there an inverted U-shaped curve relationship. (2) listed bank executive compensation and capital adequacy ratio was significantly negatively correlated, but the inverted U-shaped curve relationship between the two does not exist. (3) There are significant positive correlation between executive compensation and bank performance of listed banks. These results indicate that China’s commercial banks have not yet established an effective mechanism which aligning executive compensation with risk. A sound risk-adjusted executive compensation system need to be established, in which the role of the board and its remuneration committee in compensation management should be full played, and bank executive compensation regulation should be strengthened.