There is a widely held expectation that the share of total U.S spending devoted to health care is poised to rise dramatically some might say traumatically in the coming decades. This belief is so engrained that the focus of long-term government budget analysis is increasingly shifting towards pursuing policies that will help restrain expected growth in public health spending (Congressional Budget Office, 2007b; General Accountability Office, 2007).
The attention being paid to health costs is underscored by the following calculation: if the growth rate differential between health spending and overall economic output remains at the average value observed since 1970 a gap of just over two percentage points health spending will account for 100 percent of GDP by 2080 (Congressional Budget Office, 2007a).
The distinction between systematic and idiosyncratic risk is an integral part of the canon of corporate finance. The simple capital asset pricing model (CAPM) is perhaps its best known form. Idiosyncratic risk is readily diversified, leaving the investor exposed to systematic risk, the non diversifable component. But firms have different sensitivities to systematic risk, and systematic risk itself may be multi-dimensional with distinct risk types originating in specific industries, sectors or regions. In general, the potential for portfolio diversification then is driven broadly by these two characteristics: the degree to which systematic risk factors are correlated with each other and the degree of dependence of individual firms on different risk factors.
Although this paradigm has been developed for the analysis of risk in liquid market assets, it is nevertheless relevant to an investor in less liquid credit assets where obligor default is an event of particular interest. Models of the joint distribution of losses from a portfolio of credit assets form the cornerstone for a variety of applications in finance, from credit risk management to the pricing of credit assets such as CDOs (collateralized debt obligations) and credit derivatives. Credit risk analysis introduces another source of heterogeneity, namely the default threshold. This may vary across firms due, for instance, to different capital structures, and across countries because of, say, different bankruptcy laws.
Executive compensation has leapt to the forefront of the debate surrounding the primary causes of the recent financial crisis. Numerous accounts in the popular press speak of greedy, self-serving bank executives who took on unnecessary and excessive risks that came close to bringing about the downfall of the financial system. Central to the narrative is the hypothesis that managerial equity compensation introduces the moral hazard for excessive risk-taking in the banking industry. Several academic studies articulate the view. Among them, Bebchuk and Spamann (2010) argue that the payoffs on bank executives’ option and stock holdings are tied to highly levered bets on the value of the banks’ capital, providing powerful incentives for excessive risk-taking. Can criticisms of unbridled executive compensation and excessive risk-taking in the banking industry be empirically validated? What are the channels through which executives increased risk?
