Does Compensation Drive Systemic Risk? Evidence from the Tunisian Banking Sector

Weak and ineffective bank governance mechanisms are identified as the main triggers of a financial crisis. One of the main issues raised by researchers is the role of executive compensation in encouraging risk-taking. We conduct this research to determine whether executive compensation is an incentive for risk-taking and contributes to the overall systemic risk for a sample including seven banks from the biggest private Tunisian listed banks over the period 2009-2019. Based on the agency theory and the moral hazard hypothesis, compensation is assumed to be an incentive for interest and risk preferences alignment. Indeed, our results show that managers are willing to take excessive risks that may increase systemic risk levels. Managers tend to be risk seeking to increase bank performance and are motivated to keep their position, and their job opportunities. Surprisingly, the robustness test highlights that only fixed component is related to systemic risk measures suggesting that, provided with fixed wages, managers feel safe and are not reluctant to invest in all projects reporting positive net present value irrespective of their risk which may result in excessive risk taking.