CEO inside debt compensation determinants and bank performance: Empirical evidence from Europe

The main purpose of this paper is to examine the effect of inside debt compensation on bank performance, and identify the determinants of inside debt compensation. Using a sample of thirty European Banks during the period of 2006-2011, this paper presents evidence to support the existing literature that states that debt-based compensations plans have a significant impact on banks? performance. The results imply that banks rely more on a debt-based compensation as leverage increases. A positive association has also been documented between debt-based compensation usage and both CEO age and bank size. The human capital of CEOs has been found to be negatively related to debt-based compensation. The empirical findings show that there is a significant negative relationship between inside debt compensation and banks' performance. Specifically, CEOs paid with a higher level of inside debt compensation were more likely to engage in lower risk-seeking behavior, such as adopting more conservative policies and investment choices. Thus, inside debt compensation plans can influence the risk-taking of managers, which may have the potential to significantly affect bank performance. Generally, inside debt compensation can reduce risk-shifting problems and lead to behavior which positively impacts debt-holders, as less risk-taking can directly contribute to a lower probability of default. The findings of this paper present important implications for many interested parties throughout the European Union, such as regulators, investors, and standards setters, whose aim is to enhance the soundness of the banking sector.