MANAGERIAL RENTS AND REGULATORY INTERVENTION IN TROUBLED BANKS

In this paper we investigate the effects of regulatory policies on tro ubled banks. In our analysis banks' portfolio decisions are unobservab le and are made by management. Management's decisions are influenced b y the compensation and intervention policies of shareholders and regul ators as well as the impact of its portfolio choice on its share of fi rm-specific rents. We demonstrate that firm-specific rents may induce managers to prefer risky asset portfolios. These incentives may be exa cerbated by shareholder-designed compensation contracts intended to al ign managerial and stockholder interests. Depending on the parametric specifications of the model, both the often-criticized practice of reg ulatory forbearance and the compensation regulations proposed in the F ederal Deposit Insurance Corporation Improvement Act of 1991 may form part of the deposit-insurance-loss-minimizing regulatory policy.