Effectiveness and (In)Efficiencies of Compensation Regulation: Evidence from the EU Banker Bonus Cap

We investigate the (unintended) effects of bank executive compensation regulation. Capping the share of variable compensation did not induce an executive director exodus from EU banking because banks raised fixed compensation sufficiently to retain executives. However, risk-adjusted bank performance deteriorated, consistent with reduced incentives to exert effort and insurance effects associated with fixed compensation components. We also find that banks with directors that are more affected by the bonus cap exhibit more systemic as well as systematic risk. This result casts doubts on the effectiveness of the policy to achieve its aim to enhance financial stability.