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Publications
  • April 2015
  • Article
  • Journal of Finance

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

By: Shawn Cole, Martin Kanz and Leora Klapper
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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. We first show 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 credit officers. Second, we present 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.

Keywords

Banking; Management Processes; Credit Products; Experimental Economics; Risk Management; Motivation and Incentives; Management Practices and Processes; Financing and Loans; Banking Industry

Citation

Cole, Shawn, Martin Kanz, and Leora Klapper. "Incentivizing Calculated Risk-Taking: Evidence from an Experiment with Commercial Bank Loan Officers." Journal of Finance 70, no. 2 (April 2015): 537–575.
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About The Author

Shawn A. Cole

Finance
→More Publications

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More from the Authors
  • Can Gambling Increase Savings? Empirical Evidence on Prize-Linked Savings Accounts By: Shawn A. Cole, Benjamin Iverson and P. Tufano
  • Engine No.1: An Impact Investing Firm Engages with ExxonMobil By: Mark Kramer, Shawn Cole, Vikram S. Gandhi and T. Robert Zochowski
  • Changing Gambling Behavior through Experiential Learning By: Shawn A. Cole, Martin Abel and Bilal Zia
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