June 19, 2012
Compensation as an Incentive for Talent
By Cindy Ivanac-Lillig
In Michael Lewis’s book, The Big Short, one of the main protagonists sets up a couple of meetings with people from different rating agencies. Before the meetings, he wonders if the folks from the rating agencies will be able share with him something he doesn’t know or hasn’t thought of in the course of his own analysis of the mortgage market. But shortly after the meetings, he comes to the conclusion that they, as well as most regulators, don’t understand the market at all. Not only did they not share anything new, but they seemed poorly informed. Clearly when it came to understanding the intricacies of financial instruments and risk modeling in the mortgage market, there was an A Team and a B Team on Wall Street. And in his opinion, the rating agencies were not the A Team.
It is a pretty amusing snippet in the book, but the underlying presumption that investment banks attract more and better talent due to the opportunities and compensation available is not a new idea.
Frankly, it seems pretty logical. Even though, there are plenty of people who work in many different public service/policy sectors who are very smart and are knowingly giving up larger salaries in order to work in their chosen fields, the earnings gap in the field of finance seems quite large. I haven’t come across a good study yet, but based on anecdotal information, it seems larger than in many other fields.
In addition to the compensation disparity, there is also a question of skill set. Not all financial skill sets are the same. The business of banking – that is taking in deposits and making loans – seems rather quaint when compared with the business of financial engineering and synthetic credit portfolio management. The requisite skill set on Wall Street and in the public sphere may be ever-changing, more global, and more inter-disciplinary than it ever was. And perhaps while Wall Street has figured out a relatively easy way to attract some of these skills through compensation, the public sector has been slow to recognize the shift in skill set and even slower in trying to figure out how to attract more of this talent.
For all the economics students out there who believe strongly in incentives, what are some potential solutions that would help rating agencies, regulators, and policymakers achieve a level of skill parity? Is compensation the best and only way? Or do you disagree with The Big Short premise that there is an A Team and a B Team?
Posted by Cindy at June 19, 2012 10:11 PM
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