Banking, Regulation, and Incentive Structures

This research group aims to advance our understanding of how banking activities, regulations, and incentives interact. Regulatory interventions can produce unintended consequences that undermine their efficacy and cause potential adverse effects on the financial sector and the broader economy, especially when we overlook the impact on incentives. The group’s research contributes to the debate on how to design and implement incentive-compatible and cost-efficient regulations. 

First, we take a birds-eye perspective on different regulatory measures that could be ineffective or associated with unintended consequences. In one project, we empirically examine the impact of outstanding contingent convertible (CoCo) bonds on bank stability and reporting. While these hybrid securities can strengthen banks’ capital bases, we find that persistent uncertainty and misconceptions among investors about bail-in likelihoods limit their monitoring engagement, which results in banks becoming less transparent. In other ongoing research, we study whether the unbundling of research fees from sales commissions introduced by MiFID II is sufficient to overcome conflicts of interest analysts face. 

In a second line of research, we strive to understand the interplay of extrinsic motivation driven by regulatory requirements with intrinsic motivation rooted in prosocial behavior traits and norms in finance professionals’ risk-taking decisions. To this end, we conduct several experiments with bank employees in which we manipulate compensation, social awareness, and regulatory stringency. 

Lastly, we examine whether regulatory due diligence requirements push firms to extend control beyond their boundaries as intended by the legislator, or if they primarily incentivize firms to minimize liability and risk by terminating relationships. In this context, we also explore the extent to which banks play a critical role in the efficacy of these regulations. 

Workpackage 1:        Unintended consequences of banking regulation

Workpackage 2:        Regulatory measures and bank employees’ incentives

Workpackage 3:        Supply chains, due diligence requirements, and the role of banks