We show that, in the presence of correlated investment opportunities across firms, risk sharing between firm shareholders and firm managers leads to compensation contracts that include relative performance evaluation. These contracts bias investment choices towards correlated investment opportunities, thus creating systemic risk. Furthermore, we show that leverage amplifies all such effects.
In the context of the banking industry, we analyze recent policy recommendations regarding firm managerial pay and show how shareholders optimally undo the policies' intended effects.
In recent years, there has been a significant increase in the issuance of sustainability-linked loans (SLLs), where loan contract terms depend on the...
The recent bailout of Credit Suisse is noteworthy for many reasons. One of them is that, while AT1 bondholders were wiped out, shareholders were not. This...