CEO Option Compensation, Risk-Taking Incentives, and Systemic Risk in the Banking Industry

This study predicts and finds that chief executive officer (CEO) risk-taking incentives induced by stock option compensation increase a bank’s contribution to systemic distress risk and systemic crash risk. We also predict and find that this CEO incentive–systemic risk relation operates through three channels: (i) a bank’s engagement in non-interest income-generating activities, (ii) investments in innovative financial products such as collateralized debt obligations and credit default swaps, and (iii) maturity mismatch associated with on short-term debt financing. Finally, the CEO incentive–systemic risk relation is moderated by information transparency, bank size, market liquidity, and financial crisis. We also discuss relevant policy implications