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Taking the Alpha Out of Finance

Would the world be better off if most financiers weren’t such alpha types?

Do we really need our bankers to be among the smartest, best-educated people around? Or, would society as a whole make out just fine – even be served better – if the finance sector were populated by and large by run-of-the-mill individuals?

Bankers’ compensation is in the news again. Lately the focus of attention seems to be shifting from how to punish bankers’ excesses, to a more two-sided conversation about long-run consequences that might flow from the seemingly inevitable turn toward stiffer government oversight of financial activities.

In a research paper dated December 2008, NYU’s Thomas Philippon and University of Virginia’s Ariell Reshef examined a century’s worth of data on bankers’ pay and found that regulation was one of three major drivers. Increased regulation discourages innovation in finance, in turn removing financial institutions’ incentive to pay up to get the best and brightest talent. Thus, the paper’s authors conclude, “Tighter regulation is likely to lead to an outflow of human capital out of the financial industry. Whether this is desirable or not depends on one’s view regarding economic externalities.”

What is your view? Are bankers overpaid? (Philippon and Reshef’s paper asserts that they are.)

More important: If more and better oversight does narrow the gap between compensation in finance vis-a-vis other sectors of the economy, is that a winning scenario for everyone except bankers? If the most creative, talented, hard-driving minds stop crowding into financial occupations – thereby bringing about a simpler and less innovative financial sector – will society as a whole be unambiguously better off?

Comments (10)

  1. Answering a question with a question:

    How large is the intersection between these two sets of people with the talent and ability to, with appropriate education and training, perform at “best and brightest” level in finance:

    (1) those who are overwhelmingly motivated by money, for whom the difference between a $200,000 annual income and a $2 million annual income will affect their career choice, and, in order to earn the higher amount lead them to live workaholic, highly materialistic lives, possibly sacrificing health, happiness, and family; and

    (2) those who find themselves intellectually challenged, fascinated, and self-actualized by working in finance?

    I’d say there is considerable overlap, and the latter will still choose to work in finance even if the financial reward is less.

    Maybe all the money being paid out in recent years even selected more in favor of the first group, so finance in fact attracted a lot who were NOT the best and brightest, just the most willing to sacrifice for top pay — and who collectively made a vast set of shortsighted, catastrophic decisions.

  2. What I enjoy most about the environment of the front office is that I only interact with the highest quality people – tall, athletic, attractive, ambitious alpha men and women who share the same qualities and mindsets. The last thing I would want is to share the environment with lower calibre people. The credit crunch has been great in removing the lower quality dead weight and just keeping the cream of the crop. Let it continue!

  3. At least it’s kept you off the streets. There are aesthetics to be considered, after all.

  4. Jan, your comments prove that there still is, as you name it, “lower quality dead weight” to be disposed of and you might be part of it!!
    I do not know which trading floor you are working on but throughout my career those I have seen succeed on the long term where not the tall, athletic ambituous alpha men/women, rather those who knew what the hell they were doing.

    To get back to the initial question, the broader question should not be the impact of overregulation on bankers pay, but rather its impact on the real economy (isn’t asking banks to reserve more capital and lend to the real economy contradictory?)
    Regulators have to put in place a globally homogenous and flexible financial regulatory framework able to cope with the rapidity of innoviations in finance. Also, what about paying regulators fairly to attract talent? This might have prevented the blns of $ that governments are throwing at financial institutions.

  5. Jan, you are totally deluded. Isn’t it your “tall, attractive, ambitious” colleagues who just destroyed the global economy? You make me laff.

  6. Since when has banking been populated by the brightest? The most ambitious yes, and the most motivated by position and money, yes. The brightest – not a chance. Since I left banking, I have met far more intelligent, thoughtful and insightful people than your average banker. M&A, finance etc. aren’t remotely intellectually challenging – most of it is extremely dull and repetitive in fact.

  7. What I find amusing is that you continually find people on these web forums that firmly believe their contribution to society as a Banker justifies being paid such huge sums of money, for what, at the end of the day, generates very little value for the greater good – & in many cases destroys it. Unfortunately the compensation structure inherent in the industry reinforces that self delusion. Thankfully the day of reckoning for the industry is upon us & some of these egos will be deflated when they have to get by on much more meagre pay packets…

  8. Is not the fact that all these talented smart intellegent individuals failed to understand the instruments they created and the implications of their inadequate modelling proof that the business has indeed already been populated by second or third tier people.

    Look up the John Bird and John Fortune credit crisis clip on youtube. That was from August 2007 and a lot more credible than the supposed titans of finance ever were.

  9. Irrespective of how much money you make, if you work for an investment bank owned by third parties you are still just an employee operating in an externally imposed framework. There are plenty of talented people in banking but if you are willing to take risks and know how to create opportunities you can do much more with your talent.

  10. “What I enjoy most about the environment of the front office is that I only interact with the highest quality people – tall, athletic, attractive, ambitious alpha men and women who share the same qualities and mindsets.”

    What are you smokin? my front office is filled with overworked, unhealthy, unathletic, nerdy, ambitious but greedy men and women

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