The Limits to Compensation in the Financial Sector
In recent years bonuses tied to performance have become commonplace in banks and other financial institutions; indeed they now constitute a major part of employee compensation.� The practice was originally justified by academic work on principal-agent contracts, which argued that performance bonuses would better align the interests of managers and shareholders.� In this article we argue that such schemes are not well-suited to aligning these interests in the financial sector.� There are two reasons for this failure.� First, new financial products make it easy to create the appearance of superior performance over long periods of time even though the outsize returns are merely being driven by hidden tail risk.� We show that it is virtually impossible to create performance contracts that get around this problem.� Second, the complexity of new products and the size of modern financial institutions make it extremely difficult (and costly) to monitor risky activities directly.� As in the first case, compensation schemes, including deferred compensation, are inefficient substitutes because it is easy to escape detection for long periods of time.� This opens the door for outright fraud.� We argue that a greater emphasis on ethical values, e.g., a duty of care to customers and shareholders, is more likely to produce effective reforms.
|Date of creation:||12 Dec 2012|
|Date of revision:|
|Contact details of provider:|| Postal: |
Web page: http://www.economics.ox.ac.uk/
More information through EDIRC
When requesting a correction, please mention this item's handle: RePEc:oxf:wpaper:635. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Caroline Wise)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.