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

Shawn  Cole; Martin  Kanz; Leora  Klapper

Article | Journal of Finance | April 2015

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; Risk Management; Motivation and Incentives; Management Practices and Processes; Financing and Loans; Banking Industry;

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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.

Impact investing has grown significantly over the past 15 years. From a niche investing segment with only $25 billion AUM in 2013 (WEF 2013), it experienced double-digit growth and developed into a market with an estimated $502 billion AUM (Mudaliapar and Dithrich 2019). Despite the growth and maturation of impact investing, gathering complete and accurate data on the characteristics of this industry continues to be a challenge. This paper describes the creation of a new dataset on both impact investors and the portfolio companies they fund, comprising 409 impact investors and 13,212 portfolio companies. We code impact investors according to established categories such as legal form, types of investments and return objectives. We then develop measures of the relative importance of social impact for each investor in an effort to add a new analytic categorization. We conclude by describing the distribution of investors and firms across these various categories.

Working Paper | 2020

Anchors Aweigh: Analysis of Anchor Limited Partner Investors in Impact Investment Funds

Shawn A. Cole, Rob T. Zochowski, Fanele Mashwama and Heather McPherson

This note describes results from a survey of “anchor investors” in impact funds. Anchor investors are described as “generally the first investor to make a substantial capital commitment to a fund,” (according to the Global Impact Investing Network, “GIIN”) and their role is often thought to be an important determinant of the fund’s ultimate ability to raise meaningful amounts of investable capital. We survey 13 fund managers, who collectively provide information for 28 funds. We also conduct qualitative interviews with six anchor investors. We find the following: the average number of anchor investors per fund is one; however, 16 out of 28 funds report having no anchor investor; anchor investors invest $8 million into funds on average whereas non-anchors invest $4.5 million. We also note that reinvestment rates seem relatively low: anchor investors reinvest in subsequent funds in 8% of cases, while non-anchors reinvest 17% of the time. We show that the type of investors who are anchor investors is similar to that of non-anchor investors. Our results suggest that anchor investors can play a valuable market-building role for impact fund managers. The large investments anchors make may be particularly helpful to new fund managers who might have limited distribution and sales capacities. Interviews with anchor investors also suggest a catalytic “halo” effect for funds receiving anchor investments, as funds benefit from an early endorsement by a respected investor.

A limitation of this study is its relatively small sample size, which precludes us from investigating potentially interesting relationships. We nevertheless believe this note has value, as this is perhaps the first and only investigation of the role of anchor investors in the formation of new funds. Many larger investors have articulated a desire not just to invest for impact, but to seed and support the industry.

Keywords: impact investment funds; anchor investors; Investment; Surveys; Analysis;

Citation:

Cole, Shawn A., Rob T. Zochowski, Fanele Mashwama, and Heather McPherson. "Anchors Aweigh: Analysis of Anchor Limited Partner Investors in Impact Investment Funds." Working Paper, May 2020. View Details

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We have each experienced thrills and pain while supporting the mission of the Abdul Latif Jameel Poverty Action Lab, which facilitated many of the experiments described in the 2019 Nobel Prize citation. J-PAL in many ways seeks to fulfill what Angrist and Pischke called the “Credibility Revolution in Empirical Economics.” Even though (or perhaps because) we have conducted many RCTs, we share many of the concerns that critics have highlighted: high cost, long time lags, and limits to generalizability. Yet, we are quite optimistic that the impact and reach of experimental work in economics and policy will only grow. We see two complementary developments that will make RCTs cheaper, faster, larger, and ultimately substantially more insightful. First, a new research literature seeks to improve the design of experiments, and what we can learn from them, through improved methodologies, meta-analyses, and improved understanding of heterogeneity. Second, the rise of administrative data rapidly opens new frontiers of investigation, in particular the possibility of “closed-loop” data environments, in which interventions can be delivered and evaluated digitally, often on very large samples, and often iteratively.

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

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