Bankers’ stock options, risk-taking and the financial crisis

•An examination of the relationship between stock options use and bank risk in the context of the 2007–2008 financial crisis.•Data are based on banks authorised to accept deposits in the United Kingdom.•Banks’ total risk and insolvency risk increase with bankers’ risk-taking incentives induced by stock options.•Provides empirical support for the European regulation on variable pay.

This study investigates the relationship between the use of stock options and bank risk in the context of the 2007–2008 financial crisis for banks that are authorised to accept deposits in the United Kingdom. These banks are affected by the European regulation on variable pay, but, to our knowledge, their usage of stock options has not been examined in previous studies. Paying bankers with stock options can generate two types of managerial incentives, namely, incentives to improve performance and incentives to take risk. Controlling for incentives to improve performance, we find that banks’ total risk and insolvency risk increase with the risk-taking incentives induced by stock options. We also find that this relationship is more pronounced surrounding the crisis period. The findings of this study can serve as institutionally relevant empirical support for the European regulation on variable pay.