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 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.

Bibliographic Details

Main Authors:	Cole, Shawn, Kanz, Martin, Klapper, Leora
Language:	English en_US
Published:	World Bank, Washington, DC 2012-07
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 https://hdl.handle.net/10986/12002
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