An analysis of the impact of executive incentives on the sustainability of the banking industry

Abstract

The sustainability of the banking industry has been proven beyond a doubt to be of principal importance due to it being densely interlinked with the economy and in the process possesses systemic risk. As this industry poses such a herculean amount of systemic risk, its actions, or lack thereof, affects every taxpayer. These taxpayers, more often than not, are unaware of the complex and unique features of the banking industry, while these industries could indeed cause recessions and depressions. The latest of which was the credit crisis of 2007 – 2009, a result of reckless lending, borrowing and spending. In addition, when the crisis struck and the government had to “bail” these institutions out, they did so with taxpayers’ money. In this study, the researcher analysed specifically what impact executive incentives had on the sustainability of the banking industry. With a remuneration and incentive system in place that in actual fact rewards excessively high risk-taking, the researcher is of the opinion that another recession or even depression might not be in the distant future. Six propositions were verified in this study. In the first proposition, the impact of the banking sector on the overall economy was investigated, and it was accepted. In the second proposition, it was stated that executive remuneration paid in cash had decreased after the credit crisis, while the remuneration in equity had increased, which was not accepted. In proposition three it was stated that executive remuneration in the form of cash had an impact on risk-taking in the banking sector, which was accepted. While in proposition four it was stated that an increase in executive remuneration in the form of cash leaded to an increase in risk-taking, which was discovered not to be valid and thus was not accepted. In proposition five it was stated that the remuneration of executives by equity instead of cash would also have an impact on risk-taking, this statement was found to be valid and was thus accepted. Finally, in the last proposition it was stated that an increase in executive incentives in the form of equity value would lead to a decrease in risk-taking, which was found to be invalid and was thus not accepted. The primary objective of the researcher in this study was to identify and evaluate whether or not executive incentives led to increased risk-taking. The secondary objective was to clarify concepts, the relationship between executive incentives and risk-taking, and to identify criteria to measure and manage risk-taking by means of z-scores. The researcher came to the conclusion that linking executive remuneration to debt could present a possible solution