Bonuses, options, and bank strategies

Abstract

This study focuses on the management financial incentives that banking institutions adopt, with the purpose of best serving their corporate strategies. Specifically, a comparative study is carried out between medium- and long-term incentives, under the form of option-based pay, and short-term incentives, which take the form of bonus-based pay. Banking institutions should seek for the best balance between the two types of compensation, weighing their pros and cons under the specific market conditions they face. The paper advocates in favor of including the options modality in incentive packages, given that it stimulates the alignment of interests between owners and managers, allowing these last ones to act in an independent but responsible manner. Bonuses, in turn, require additional shareholders’ supervision, which might be advantageous when the need to reverse harmful effects of poor performance arises. The developed theoretical model is complemented with two numerical exercises (one with simulated data and the other with real data) that corroborate the model’s conjectures.