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Determinants of the use of financial incentives in investment banking

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  • David Nash
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    Abstract

    This paper examines the use of incentive pay schemes within the financial services sector in London. Various theories of wage determination are reviewed with particular attention placed on the principal-agent literature as a framework for analysing the use of incentive pay. This is combined with case study interviews and a number of hypotheses regarding the use of bonuses. Quantitative analysis of a detailed industry-wide survey validates the hypothesis that those occupations where output is easily identifiable receive higher bonus pay. The proximity of an occupation to the revenue generating activity within the organisation is also found to be significant in determining bonus levels, as is job grade within the organisation. The paper concludes that principal-agent theories of wage determination are useful in understanding the use of bonus pay in the City, but need to be modified to take account of particular institutional characteristics, in particular the power of individual agents.

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    Bibliographic Info

    Paper provided by ESRC Centre for Business Research in its series ESRC Centre for Business Research - Working Papers with number wp256.

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    Date of creation: Mar 2003
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    Handle: RePEc:cbr:cbrwps:wp256

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    Web page: http://www.cbr.cam.ac.uk/

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    Keywords: Incentive pay; principal-agent theory; investment banking;

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    1. Sanford Grossman & Oliver Hart, . "An Analysis of the Principal-Agent Problem," Rodney L. White Center for Financial Research Working Papers 15-80, Wharton School Rodney L. White Center for Financial Research.
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    8. Mirrlees, James A., 1996. "Information and Incentives: The Economics of Carrots and Sticks," Nobel Prize in Economics documents 1996-1, Nobel Prize Committee.
    9. Joseph E. Stiglitz, 1973. "Incentives and Risk-Sharing in Sharecropping," Cowles Foundation Discussion Papers 353, Cowles Foundation for Research in Economics, Yale University.
    10. Green, Jerry R & Stokey, Nancy L, 1983. "A Comparison of Tournaments and Contracts," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 349-64, June.
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    15. Gary S. Becker, 1975. "Human Capital: A Theoretical and Empirical Analysis, with Special Reference to Education, 2nd ed," NBER Books, National Bureau of Economic Research, Inc, number beck75-1, May.
    16. Brian J. Hall, 1998. "The Pay to Performance Incentives of Executive Stock Options," NBER Working Papers 6674, National Bureau of Economic Research, Inc.
    17. Ronald G. Ehrenberg & Michael L. Bognanno, 1990. "The incentive effects of tournaments revisited: Evidence from the European PGA tour," Industrial and Labor Relations Review, ILR Review, Cornell University, ILR School, vol. 43(3), pages 74-88, February.
    18. Akerlof, George A, 1982. "Labor Contracts as Partial Gift Exchange," The Quarterly Journal of Economics, MIT Press, vol. 97(4), pages 543-69, November.
    19. Canice Prendergast, 1999. "The Provision of Incentives in Firms," Journal of Economic Literature, American Economic Association, vol. 37(1), pages 7-63, March.
    20. Hart, Oliver D, 1983. "Optimal Labour Contracts under Asymmetric Information: An Introduction," Review of Economic Studies, Wiley Blackwell, vol. 50(1), pages 3-35, January.
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    Cited by:
    1. Grund, Christian & Walter, Tanja, 2013. "Management Compensation and the Economic Crisis: Longitudinal Evidence from the German Chemical Sector," IZA Discussion Papers 7435, Institute for the Study of Labor (IZA).

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