Optimal design of deferred compensation for bank executives under agency conflicts

Abstract

We analyze the optimal design of deferred compensation for bank executives under agency conflicts in a continuous time model with a bank liability structure. Our model demonstrates that a well-designed deferred compensation contract can effectively mitigate bank executives' asset substitution problem and significantly enhance the total value of the bank, which aligns with existing empirical studies. Moreover, we find that the motivation for bank executives to shift risk under deferred compensation is diminished when supervision is more stringent, the bank has greater market power, or the write-down ratio of debt is lower.