We present a model where bank assets are a portfolio of risky debt claims and analyze stockholders' risk-taking behavior while considering the strategic interaction between debtors and creditors. We find that: (1) as the leverage of a bank increases, risk shifting by borrowers increases, even if...

In this paper we present a model of executive compensation to analyze the link between incentive compensation and risk taking. Our model takes into account the loss in the value of an executive's expected wealth from employment if the firm becomes insolvent during a bad state of the economy. We...

We study the influence of unsecured debt (subdebt) and of bail-in debt on banks' risk-taking in a contingent claim model, while considering the bargaining between stockholders and debtholders. We show that replacing stock with subdebt: (1) leads to fewer risk-shifting events, but generates a...

Black and Cox (1976) claim that the value of junior debt is increasing in asset risk when the firm's value is low. We show, using closed-form solution, that the junior debt's value is hump-shaped. This has interesting implications for the market-discipline role of banks' junior debt (subdebt)

We present an equilibrium model of financial institutions to examine the optimal regulation of risk taking. Shareholders set compensation incentivizing management to increase risk to excessive levels. Regulators use caps on asset risk and compensation to achieve the socially optimal risk level....