Working Paper: NBER ID: w19594
Authors: Thomas F. Cooley; Ramon Marimon; Vincenzo Quadrini
Abstract: Over the last three decades there has been a dramatic increase in the size of the financial sector and in the compensation of financial executives. This increase has been associated with greater risk-taking and the use of more complex financial instruments. Parallel to this trend, the organizational structure of the financial sector has changed with the traditional partnership replaced by public companies. The organizational change has increased the competition for managerial talent, which may have weakened the commitment between investors and managers. We show how increased competition and the weaker commitment can raise the managerial incentives to undertake risky investment. In the general equilibrium, this change results in higher risk-taking, a larger and more productive financial sector with greater income inequality (within and across sectors), and a lower market valuation of financial institutions.
Keywords: Risky Investments; Managerial Incentives; Financial Sector; Income Inequality
JEL Codes: E25; E44; G01; G3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Increased competition for managerial talent (M51) | Higher managerial incentives to undertake risky investments (G39) |
| Higher managerial incentives to undertake risky investments (G39) | Larger and more productive financial sector (O16) |
| Larger and more productive financial sector (O16) | Greater income inequality within and across sectors (D31) |
| Increased competition for managerial talent (M51) | Lower market valuation of financial institutions (G21) |
| Transition from partnerships to public corporations (L33) | Weakened commitments between investors and managers (G34) |