|
Working Paper
| HBS Working Paper Series
| 2012
Incentivizing Calculated Risk-Taking: Evidence from an Experiment with Commercial Bank Loan Officers
by
Shawn Cole, Martin Kanz and Leora Klapper
|
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;
risk management;
credit products;
experimental economics;
Banks and Banking;
Motivation and Incentives;
Risk Management;
Banking Industry;
India;