The Owner–Manager Conflict in Insured Banks: Predetermined Salary versus Bonus Payments

A study examines the incentives of a bank's owners and manager to increase the level of assets risk if bank deposits are insured. The model consists of 3 players: a public insurer, the bank's owners, and its manager. In the model, the form of compensation to the manager plays a crucial role in determining the level of asset risk. The study shows under which conditions and form of compensation the bank's owners and manager have an incentive to raise the risk level. The model is run first under the assumption that the information between the bank and the insurer is symmetrical, and then under the assumption that it is asymmetrical for 2 forms of pay: a predetermined salary; and bonus payments whose value is not known at the time the contract between the owners and the manager is signed. The study also examines whether there is a Pareto-optimal contract between the owners and the manager in regard to the risk level, given the 2 forms of pay. The absence of such a contract could indicate the existence of a source of instability in the banking system.