Taking the Alpha Out of Finance

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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?

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