Designing Executive Compensation for Banks and Financial Institutions

When it comes to banks and
financial institutions, there are additional corporate governance requirements
apart from those applicable to other types of companies. This is because the
operation of banks and financial institutions affect the interests of a
constituency other than shareholders, namely deposit holders and other
creditors. Hence, executive compensation practices need to take these special
issues into account.
In this regard, a recent article in
the Economic & Political Weekly (EPW) titled Contingent
Convertibles and Bankers’ Pay
by Mandar Kagade and Aadhaar Verma is
instructive. The abstract is as follows:

The compensation
practices at large financial institutions are often held as one of the
important factors which contributed to the 2007/2008 global financial crisis.
Regulators around the world, including India, have therefore moved to enact
prescriptions aimed at increasing shareholder oversight of executive pay. Set
against this background, the paper makes two novel proposals focusing on the
Indian context. First, it nudges the regulators to prescribe creditor-centric
compensation rules at banks. The Reserve Bank of India has hitherto focused on
pay reforms that will promote incentive alignment between executives and
shareholders. This paper argues that such reforms are likely to promote more
rather than less risk-taking among bank executives. Second, it argues that the
RBI ought to mandate banks to pay a substantial portion of the managerial
compensation in contingent capital bonds. The design of these bonds can
significantly motivate executives to “think like creditors” and
thereby enable avoidance of taxpayer-funded bailouts.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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