Leverage, CEO Risk-Taking Incentives and Bank Failure during the 2007-2010 Financial Crisis

Abstract

We propose a simple measure of the risk-taking incentives of the CEOs of highly levered financial institutions, levered delta, which captures the incentives to take on risk generated by CEOs' stock holdings. Using this measure, we find that stronger CEO risk-taking incentives prior to the 2007-2010 financial crisis are associated with a higher probability of bank failure during the crisis. We find no evidence that risk-taking incentives or bank failure are related to corporate governance failures. However, CEOs' risk-taking incentives appear to be aligned with shareholders' incentivesto shift risk to other claim holders.