Skip to Main Content
HBS Home
  • About
  • Academic Programs
  • Alumni
  • Faculty & Research
  • Baker Library
  • Giving
  • Harvard Business Review
  • Initiatives
  • News
  • Recruit
  • Map / Directions
Working Knowledge
Business Research for Business Leaders
  • Browse All Articles
  • Popular Articles
  • Cold Call Podcast
  • Managing the Future of Work Podcast
  • About Us
  • Book
  • Leadership
  • Marketing
  • Finance
  • Management
  • Entrepreneurship
  • All Topics...
  • Topics
    • COVID-19
    • Entrepreneurship
    • Finance
    • Gender
    • Globalization
    • Leadership
    • Management
    • Negotiation
    • Social Enterprise
    • Strategy
  • Sections
    • Book
    • Podcasts
    • HBS Case
    • In Practice
    • Lessons from the Classroom
    • Op-Ed
    • Research & Ideas
    • Research Event
    • Sharpening Your Skills
    • What Do You Think?
  • Browse All
    Incentivizing Calculated Risk-Taking: Evidence from an Experiment with Commercial Bank Loan Officers
    30 Aug 2012Working Paper Summaries

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

    by Shawn Cole, Martin Kanz and Leora Klapper
    Recent research presents convincing evidence that incentives rewarding loan origination may cause severe agency problems and increase credit risk, either by inducing lax screening standards or by tempting loan officers to game approval cutoffs even when such cutoffs are based on hard information. Yet to date there has been no evidence on whether performance-based compensation can remedy these problems. In this paper, the authors analyze the underwriting process of small-business loans in an emerging market, using a series of experiments with experienced loan officers from commercial banks. Comparing three commonly implemented classes of incentive schemes, they find a strong and economically significant impact of monetary incentives on screening effort, risk-assessment, and the profitability of originated loans. The experiments in this paper represent the first step of an ambitious agenda to fully understand the loan underwriting process. Key concepts include:
    • High-powered incentives that penalize the origination of non-performing loans while rewarding profitable lending decisions cause loan officers to exert greater screening effort, approve fewer loans, and increase the profits per originated loan.
    • In line with predictions, these effects are weakened when deferred compensation is introduced.
    • More surprisingly, they find that incentives actually have the power to distort loan officers' perceptions of how a loan will perform. More permissive incentive schemes lead loan officers to rate loans as significantly less risky than the same loans evaluated under pay-for-performance.
    LinkedIn
    Email

    Author 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.

    Paper Information

    • Full Working Paper Text
    • Working Paper Publication Date: July 2012
    • HBS Working Paper Number: 13-002
    • Faculty Unit(s): Finance
      Trending
        • 23 May 2023
        • Research & Ideas

        Face Value: Do Certain Physical Features Help People Get Ahead?

        • 25 Jan 2022
        • Research & Ideas

        More Proof That Money Can Buy Happiness (or a Life with Less Stress)

        • 25 Feb 2019
        • Research & Ideas

        How Gender Stereotypes Kill a Woman’s Self-Confidence

        • 16 May 2023
        • HBS Case

        How KKR Got More by Giving Ownership to the Factory Floor: ‘My Kids Are Going to College!’

        • 09 May 2023
        • Research & Ideas

        Where to Find Remote Work Now: 250 Million Job Postings Paint a Complex Picture

    Shawn A. Cole
    Shawn A. Cole
    John G. McLean Professor of Business Administration
    Contact
    Send an email
    → More Articles
    Find Related Articles
    • Accounting
    • Human Resources
    • Wages

    Sign up for our weekly newsletter

    Interested in improving your business? Learn about fresh research and ideas from Harvard Business School faculty.
    This site is protected by reCAPTCHA and the Google Privacy Policy and Terms of Service apply.
    ǁ
    Campus Map
    Harvard Business School Working Knowledge
    Baker Library | Bloomberg Center
    Soldiers Field
    Boston, MA 02163
    Email: Editor-in-Chief
    →Map & Directions
    →More Contact Information
    • Make a Gift
    • Site Map
    • Jobs
    • Harvard University
    • Trademarks
    • Policies
    • Accessibility
    • Digital Accessibility
    Copyright © President & Fellows of Harvard College