Does Compensation Drive Systemic Risk? Evidence from the Tunisian Banking Sector

Abstract

Weak and ineffective bank governance mechanisms are \nidentified as the main triggers of a financial crisis. One of the main issues \nraised by researchers is the role of executive compensation in encouraging \nrisk-taking. We conduct this research to determine whether executive \ncompensation is an incentive for risk-taking and contributes to the overall \nsystemic risk for a sample including seven banks from the biggest private \nTunisian listed banks over the period 2009-2019. Based on the agency theory and \nthe moral hazard hypothesis, compensation is assumed to be an incentive for \ninterest and risk preferences alignment. Indeed, our results show that managers \nare willing to take excessive risks that may increase systemic risk levels. Managers tend to be risk seeking \nto increase bank performance and are motivated to keep their position, and \ntheir job opportunities. Surprisingly, the robustness test highlights that only \nfixed component is related to systemic risk measures suggesting that, provided \nwith fixed wages, managers feel safe and are not reluctant to invest in all \nprojects reporting positive net present value irrespective of their risk which \nmay result in excessive risk taking.