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

We conduct an experiment with commercial bank loan officers to test how performance compensation affects risk-assessment and lending. High-powered incentives lead to greater screening effort and more profitable lending decisions. This effect is, however, muted by deferred compensation and limited liability, two standard features of loan officer compensation contracts. We find that career concerns and personality traits affect loan officer behavior, but show that the response to incentives does not vary with traits such as risk-aversion, optimism or overconfidence. Finally, we present evidence that incentive contracts distort the assessment of credit risk, even among trained professionals with many years of experience