Incentivizing Calculated Risk-Taking : Evidence from an Experiment with Commercial Bank Loan Officers

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 ef...

Full description

Bibliographic Details
Main Authors:	Cole, Shawn, Kanz, Martin, Klapper, Leora
Format:	Policy Research Working Paper
Language:	English en_US
Published:	World Bank, Washington, DC 2012
Subjects:	ACCOUNTABILITY AGENCY PROBLEM AGENCY PROBLEMS APPROVAL PROCESS ASSET PRICES ASSET QUALITY BALANCE SHEET BANK CREDIT BANK LENDING BANK LOAN OFFICERS BANK POLICY BORROWER BRANCH BUSINESS EXPERIENCE BUSINESS OWNERS BUSINESS RISK CAPITAL ALLOCATION CAPITAL LOANS CASE OF DEFAULT CASH PAYMENTS CHECKS CLAIMANT COLLATERAL COMMERCIAL BANK COMMERCIAL BANK LOAN COMMERCIAL BANKS COMMERCIAL LENDER COMMERCIAL LENDING COMMERCIAL LOAN COMMERCIAL PAPER CONFLICT OF INTEREST CONSUMER LENDING CORPORATE FINANCE COST OF CAPITAL CREDIT APPLICATION CREDIT APPLICATIONS CREDIT AVAILABILITY CREDIT BUREAU CREDIT INFORMATION CREDIT MARKETS CREDIT OFFICER CREDIT OFFICERS CREDIT QUALITY CREDIT REPORTS CREDIT RISK CREDIT SCORE CREDIT SCORING CREDIT SCORING MODELS CREDIT-SCORING DEBT DEBT CONTRACTS DEBT SERVICE DECENTRALIZATION DEFAULT RATES DEFAULT RISK DEFAULTS DEFERRED PAYMENT DEMOGRAPHIC CHARACTERISTIC DEMOGRAPHIC CHARACTERISTICS DEPOSIT DEPOSIT INSURANCE DISCOUNT RATE DISCOUNT RATES DISPOSITIONS DUMMY VARIABLE EMERGING CREDIT EMERGING MARKETS EMPLOYEE EMPLOYERS ENFORCEABILITY ENFORCEABILITY OF DEBT CONTRACTS ENTREPRENEUR ENTREPRENEURIAL ACTIVITIES ENTREPRENEURS ENTREPRENEURSHIP EQUALITY EQUALITY OF DISTRIBUTIONS EXCLUSION EXPENDITURE EXPENDITURES FEDERAL RESERVE FEDERAL RESERVE BANK FEDERAL RESERVE BANK OF NEW YORK FINANCIAL ASSISTANCE FINANCIAL CRISIS FINANCIAL DEVELOPMENT FINANCIAL INNOVATION FINANCIAL INSTITUTION FINANCIAL INSTITUTIONS FINANCIAL INTERMEDIATION FINANCIAL MARKETS FINANCIAL PRODUCTS FINANCIAL RISK FINANCIAL STUDIES FIRMS FIXED COST FOREIGN LENDERS FORMAL BORROWING FORMAL FINANCIAL MARKETS FUTURE ASSET GENDER GOVERNMENT OWNERSHIP HOUSEHOLD INCOME IMPLICIT GUARANTEES INCENTIVE COMPATIBILITY CONSTRAINT INCENTIVE CONSTRAINTS INCENTIVES FOR REPAYMENT INCOME STATEMENT INCOME STATEMENTS INDIVIDUAL LOAN INEQUALITY INFORMATION ASYMMETRIES INSTALLMENT INSTALLMENTS INSURANCE INTEREST RATE INTEREST RATES INTERNATIONAL BANK INVENTORY JUDGMENT LENDER LENDING DECISION LENDING DECISIONS LEVELS OF DEBT LIMITED LIABILITY LINES OF CREDIT LOAN APPLICATION LOAN APPLICATIONS LOAN APPROVAL LOAN APPROVALS LOAN CHARACTERISTICS LOAN CLIENTS LOAN DEFAULTS LOAN OFFICER LOAN OFFICERS LOAN PERFORMANCE LOAN PORTFOLIO LOAN QUALITY LOAN REPAYMENT LOAN SIZE LOAN UNDERWRITING MEDIUM ENTERPRISES MORAL HAZARD NEGOTIATION NET INTEREST MARGIN NET PROFIT NON-PERFORMING LOAN NON-PERFORMING LOANS OPAQUE SMALL BUSINESSES OPTIMAL CONTRACT OUTSTANDING LOANS PAYOFFS PENALTIES PENALTY PERSONAL EXPENSES POLITICAL ECONOMY PREDICTIVE CREDIT SCORING PRESENT VALUE PRIVATE SECTOR BANKS PROBABILITY OF DEFAULT PRODUCTIVITY PROFITABILITY PROFITS PER LOAN PUBLIC SECTOR BANK PUBLIC SECTOR COMMERCIAL BANKS REMEDY REPAYMENT REPAYMENT HISTORY REPAYMENTS RESIDUAL CLAIMANT RETURN RETURNS RISK AVERSION RISK EVALUATION RISK MANAGEMENT RISK TAKING ROLE OF BANK SALARY SHAREHOLDERS SMALL BUSINESS SMALL BUSINESS CREDIT SMALL BUSINESS LENDING SMALL BUSINESS LOAN SMALL BUSINESS LOANS SMALL FIRM SMALL FIRM FINANCE SMALL-BUSINESS SMALL-BUSINESS LOANS START-UP STATE BANKS TAX UNDERLYING ASSET VALUATIONS WAGES WILLINGNESS TO PAY WORKING CAPITAL
Online Access:	http://documents.worldbank.org/curated/en/2012/07/16531326/incentivizing-calculated-risk-taking-evidence-experiment-commercial-bank-loan-officers http://hdl.handle.net/10986/12002

Description
Summary:	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.

Incentivizing Calculated Risk-Taking : Evidence from an Experiment with Commercial Bank Loan Officers

Similar Items