Abstract
We propose an indirect tax approach to analyze the effects of regulatory interference in compensation contracts, focusing on recent mandatory deferral and clawback requirements in the financial sector. Different from capital requirements, compensation regulation does not target bank shareholders’ preferences over risk choices directly but only indirectly via its effect on compensation costs. Whether moderate deferral requirements induce shareholders to incentivize higher risk-management effort depends on fundamentals governing compensation design, such as the information environment or managers’ outside options, whereas stringent deferral requirements unambiguously backfire. We characterize socially optimal deferral and clawback requirements and their interaction with capital regulation.