Study On Executive Compensation, Performance And Risks Of Commercial Banks

With the increasingly important role of the finance sector in the world economy development, the commercial bank governance has caused widespread concern. The frequent global financial crisis, especially the subprime mortgage crisis broke out in2007, has made the executive compensation incentive mechanism the focus of the world. General regulation has been conducted towards the executive compensation system of the financial institutions globally, trying to control the level of executive compensation, improve bank performance and reduce bank risks at the same time.The separation of ownership and management causes the principal-agent problem. Manager behaviors are likely to damage the interests of shareholders, due to the inconsistence of operational targets between managers and shareholders. As members of special financial groups, commercial banks present features of high debt, high risks, being opaque, strict regulation, having multi-stakeholders, among others. Therefore, executives will inevitably seek high-yield but high-risk programs in decision-making, and seek personal interests through decisions, all of which are making the principal-agent problem in commercial banks more complex.From perspectives of theoretical and empirical analysis, this paper analyses and demonstrates how the executive compensation incentive mechanism in China’s commercial banks ultimately affects bank performance and risks through bank lending behaviors. On the basis of reviewing the existing literature in related fields, this paper attempts to put forward hypotheses and then build the framework of its own after the analysis of the relationships between any two of executive compensation incentives, lending behaviors, bank performance and risks of commercial banks. Based on the sample of49commercial banks from2003-2011, the subsequent empirical research studies the relationship between executive pay and lending behaviors, bank performance and bank risks. The study found that executive compensation has a widespread impact on bank lending practices, with the higher executive compensation, the better the commercial bank performance, and the lower non-performing loan ratio. The empirical results verify the intermediary role of bank lending behaviors. The proportion of loans to manufacturing and real estate sectors, and provision coverage are intermediary variables between executive compensation and bank perfonnance; the proportion of loans to real estate sectors, provision coverage and the largest proportion of loans to a single customer are intermediary variables between executive pay and bank risks. Thus, under compensation incentives, bank executives will choose to decrease loans to real estate sectors and to raise the provision coverage to improve bank performance and reduce bank risks.Based on theoretical analysis and empirical research, the paper argues that China’s commercial banks need financial reforms, bring executive compensation incentives into play to increase bank performance and decrease bank risks. As intermediate mechanism, loans to real estate sectors and provision coverage can play a role in affect bank performance and risks. Commercial banks also need to complete the information disclosure system, the executive compensation incentives as well as the independent director system. In addition, loan audit, Dynamic Risk Assessment, the establishment of professional manager market, reduction of administrative intervention and political incentives to commercial bank executives are also needed to achieve a truly market-oriented operation of commercial banks.