Stock-Based Incentives and Performance During the Credit Crisis

Stock incentives for bank management in the 1990s increased and may have allowed management too much freedom in making risk choices and ignited the credit crisis of 2008. Contracting theory suggests stock incentives will induce better stock performance; moral hazard theory suggests stock incentives will motivate managers to undertake risky projects. This study finds, in the period of 2005-2007, CEO options are associated with negative performance supporting moral hazard theory. However, stock ownership is associated positively with performance as measured by earnings, supporting contracting theory. Director options are associated positively with performance but are not significant in for stock ownership.