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Compensating Victims of Bankrupted Financial Institutions: A Law and Economic Analysis

Purpose - The purpose of this paper is to understand the incentive effects of existing compensation mechanisms in case of the bankruptcy of a financial institution. Design/methodology/approach - The paper uses insights of law and economics to predict the effects of compensation mechanisms on the incentives of depositors, financial institutions, financial regulators and government. Findings - The paper shows that the current compensation system in The Netherlands will not provide sufficient incentives for all stakeholders to prevent the failure of a financial institution. Adjustments to this system are necessary to improve these incentives. Original/value - The paper examines for the first time the impact of different compensation mechanisms on the incentives of multiple stakeholders. It also shows how these mechanisms influence each other regarding their incentive generating capability. These findings offer important insights for policy makers.