Remuneration, risk, and financial crisis

Guy W. Ford, Tyrone M. Carlin, Nigel Finch

Research output: Chapter in Book/Report/Conference proceedingChapter

Abstract

The sharp deterioration in the subprime mortgage market in the United States in 2007 triggered a decline in confidence in global financial markets of unprecedented scale. The sizable losses that resulted in many financial institutions revealed significant weaknesses in basic market practices and principles-notably deteriorating lending and underwriting standards; excessive (undercapitalized) risk-taking; inadequate risk management processes; undue reliance on ratings of structured products; and an almost obsessive focus on actions driving short-term results with little consideration of long-term implications. In the aftermath, the attention of regulators has turned to the structure of remuneration in financial institutions, and in particular, the failure of these structures to adequately capture and adjust for the risk taken in order to earn returns. This chapter asserts that the efficacy of risk-adjusted remuneration structures relies on the resolution of three main factors: (1) risk appetite can be defined and translated into ex-ante risk measures; (2) agency problems that arise with the use of risk-adjusted performance measures can be resolved; and (3) managerial overconfidence in assessing risk can be taken into consideration in the design of remuneration structures.
Original languageEnglish
Title of host publicationThe Banking crisis handbook
EditorsGreg N Gregoriou
Place of PublicationBoca Raton, FL
PublisherCRC Press, Taylor & Francis Group
Pages521-538
Number of pages18
ISBN (Print)9781439818534
DOIs
Publication statusPublished - 2010

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    Ford, G. W., Carlin, T. M., & Finch, N. (2010). Remuneration, risk, and financial crisis. In G. N. Gregoriou (Ed.), The Banking crisis handbook (pp. 521-538). Boca Raton, FL: CRC Press, Taylor & Francis Group. https://doi.org/10.1201/9781439818541-c28