Events

Professor Arthur Morris
Assistant Professor
Department of Accounting, Business School
The Hong Kong University of Science and Technology

We provide the first evidence of credit risk shielding in the executive compensation contracts of U.S. regulated bank holding companies. The primary form of this credit risk shielding is the use of pre-provision net revenue (PPNR) as a performance measure. PPNR is a measure developed by the U.S. regulators to provide a measure of bank performance that removes the noise generated by the loan loss provision, the largest accrual on banks’ financial statements. While this measure provides a valuable measure of banks’ economic activity, its use as a measure of performance has the effect of shielding bank executive compensation from credit risk. Consistent with this unintended consequence we show that PPNR-based credit shielding is associated with regulatory attention and bank opacity, but also that PPNR-based credit shielding is associated with increased bank credit risk. Consistent with the notion that risk shielding provides incentives for risk taking, a potentially unintended consequence of regulators introduction of PPNR as a measure of bank performance.