Performance-based compensation vs. Guaranteed compensation: Contractual incentives and performance in the Brazilian banking industry

Abstract

Top management from retail banks must delegate authority to lowerlevel managers to operate branches and service centers. Doing so, they must navigate through conflicts of interest, asymmetric information and limited monitoring in designing compensation plans for such agents. Pursuant to this delegation, banks adopt a system of performance targets and incentives to align the interests of senior and unit managers. This paper evaluates the causal relationship between performance-based salaries and managers' effective performance. Using data from January 2007 to June 2009 of a large Brazilian retail banks, we find that that agents with guaranteed variable salary contracts have inferior performance compared with agents who have performance-based compensation packages. We conclude that there is a moral hazard in the behavior of agents who are subject to guaranteed variable salary contracts.