Pay Gap, Risk-taking, and the Financial Crisis

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In this study, we examine how the occurrence of the financial crisis changed the effect of pay gap on risk-taking in financial firms under two competing hypotheses: tournament theory and equity fairness/quiet life theory. Based on a sample of financial firms between 1992 and 2009, we document a positive relationship between managerial pay gap and risk-taking. More importantly, we show that the positive effect of pay gap on risk-taking in financial firms has significantly weakened since the financial crisis, which implies that the crisis may have changed the attitude of top executives away from tournament incentives and more towards reluctance in dealing with risk-increasing behaviors. Our study is among the first to provide new evidence on the differential effect of pay gap on risk-taking conditional on the occurrence of financial crisis. We also provide an insight into this new evidence by highlighting the trade-off faced by senior executives in competing for promotion-based rewards with risk-taking. Our results are robust to different proxies for pay gaps and risk-taking incentives and have important implications for executive compensation policies in this era of political and regulatory change.




This article is the authors' final published version in Banking and Finance Review, Volume 6, Issue 1, June 2014, Pages 55-73.

The published version is available at http://ccsu.financect.net/FTC205/BFR0920Papers/425-1304-1-PB.pdf. Copyright © Banking and Finance Review