Incentivizing Calculated Risk-Taking [electronic resource] : Evidence from an Experiment with Commercial Bank Loan Officers / Shawn Cole
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TextPublication details: Washington, D.C., The World Bank, 2012Description: 1 online resource (68 p.)Subject(s): Access to Finance | Banking | Bankruptcy and Resolution of Financial Distress | Banks & Banking Reform | Debt Markets | Emerging markets | Finance and Financial Sector Development | Loan officer incentives | Microfinance | Private Sector DevelopmentAdditional physical formats: Cole, Shawn: Incentivizing Calculated Risk-Taking.Online resources: Click here to access online Abstract: This paper uses a series of experiments with commercial bank loan officers to test the effect of performance incentives on risk-assessment and lending decisions. The paper first shows that, while high-powered incentives lead to greater screening effort and more profitable lending, their power is muted by both deferred compensation and the limited liability typically enjoyed by loan officers. Second, the paper presents direct evidence that incentive contracts distort judgment and beliefs, even among trained professionals with many years of experience. Loans evaluated under more permissive incentive schemes are rated significantly less risky than the same loans evaluated under pay-for-performance.
This paper uses a series of experiments with commercial bank loan officers to test the effect of performance incentives on risk-assessment and lending decisions. The paper first shows that, while high-powered incentives lead to greater screening effort and more profitable lending, their power is muted by both deferred compensation and the limited liability typically enjoyed by loan officers. Second, the paper presents direct evidence that incentive contracts distort judgment and beliefs, even among trained professionals with many years of experience. Loans evaluated under more permissive incentive schemes are rated significantly less risky than the same loans evaluated under pay-for-performance.
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