Mind the Cap? The effects of regulating bankers' pay

Abstract

In this paper we investigate how restrictions to the possibility of paying large bonuses affect employees' pay schemes and firms' ability to attract and retain workers. We focus on the Dutch bonus cap, introduced in the aftermath of the financial crisis, which limits variable pay to no more than 20\% of fixed pay for all employees in the banking sector. Using administrative data from Statistics Netherlands, we compare outcomes for banks subject to the cap with those for financial institutions not covered by the regulation. We find that affected employees experience a sharp decline in variable pay, which is almost entirely offset by an increase in fixed pay. The policy is also associated with a rise in involuntary separations from banks and a decline in hiring. All these effects are broadly consistent across the skill distribution. Overall, given the adjustment in compensation structure, our findings do not support the notion that the bonus cap impaired banks’ ability to retain their most talented employees.