How investment bankers can be incentivised to create reckless products

http://www.voxeu.org/index.php?q=node/1197

by portfolioexec • 18 years ago

1 1 18 years ago

Here's the rub: a divergence of incentives...

"The typical investment manager/financial innovator thinks: 'If I win, my profit will be proportional to the gross sales I have initiated. If I lose, I will be dismissed, and perhaps I will lose my reputation in the process.' Thinking even further, the manager realises that the downside is limited to being fired, but the upside is limitless. This asymmetry between profits and losses encourages audacity. Once a certain risk threshold is breached, the investment manager who places bets with other people’s money ignores danger. From a social point of view, the problem stems from the divergence of incentives. Even though the intermediary knows that he may suffer a severe personal loss, it will never be proportional to the losses inflicted on investors."

How investment bankers can be incentivised to create reckless products

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