The global financial crisis of 2007–2008 has given rise to new regulatory initiatives to put restrictions on the size and the term of bankers' pay. We revisit both theoretically and empirically the question of whether these regulations are justified. We model bonuses as a series of sequential...

We model a banker's future bonuses as a series of call options on the bank's profits and show that bonus caps and deferrals reduce risk-taking. However, the banker's optimal risk-taking also depends on the costs of risk-taking. We calibrate the model to US banking data and show that lengthening...