Once more on bankers’ pay

Megan McArdle makes a perfectly sensible point when she writes:

More than one smart analyst thinks that the yearly bonus regime encouraged both traders and their managers to take excess risk. I’m not sure, as an empircal matter, that I buy this argument. Most of those bankers who were allegedly gambling for free with (implicit) taxpayer money in fact lost half or more of their own fortunes in the ensuing crash. From this I infer that they did not, in fact, realize that they were gambling.

I still think that some regulation on bonuses is warranted. Indeed, I think it warranted precisely because the bankers didn’t fully appreciate the risks they were taking. By holding bonuses in escrow for, say, five years, we serve to increase the risk aversion of those bankers.  Megan implies partial agreement with the conclusion, if not the logic, a little later on:

But enforcing, say, a multi-year bonus scheme wouldn’t be terribly destructive, and it might help.

Continuing immediately on, she writes:

On the other hand, if the government starts meddling with the level of compensation, this will be disturbing both because it will not do good things for the American financial services industry, and because, well, who the hell is the government to start telling private firms that are not receiving any taxpayer money how much to pay their employees?

In general I’d agree, but we should also consider the recent work by Thomas Philippon and Ariell Reshef suggesting that remuneration in the finance sector relative to the rest of the economy for a given level of education has been especially high lately.  Here is an ungated version of their paper.  Here is the abstract:

We use detailed information about wages, education and occupations to shed light on the evolution of the U.S. financial sector over the past century. We uncover a set of new, interrelated stylized facts: financial jobs were relatively skill intensive, complex, and highly paid until the 1930s and after the 1980s, but not in the interim period. We investigate the determinants of this evolution and find that financial deregulation and corporate activities linked to IPOs and credit risk increase the demand for skills in financial jobs. Computers and information technology play a more limited role. Our analysis also shows that wages in finance were excessively high around 1930 and from the mid 1990s until 2006. For the recent period we estimate that rents accounted for 30% to 50% of the wage differential between the financial sector and the rest of the private sector. [emphasis added]

… which is prima facie evidence in support of some sort of regulation on remuneration in the finance sector.

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