Investment banking careers: An equilibrium theory of overpaid jobs

Finance

Speaker:Ulf Axelson, LSE
Date: Friday 15 October 2010
Time: 14:00
Location: MBA LT

Further details

We analyze a general equilibrium labor market model where moral hazard problems are a key concern. We show that variation in moral hazard across types of jobs explains contract terms, work patterns over time, and promotion structures. We explain why high-profile jobs such as investment banking pay more and give higher utility to the employee than other jobs, even if employees have no skill advantage. These jobs also have up-or-out contracts, and inefficiently long hours. Our model also provides a natural theory for promotion to more important tasks after success. We also derive two versions of talent misallocation: High profile employers like investment banks may lure workers whose talent would be more valuable elsewhere, and may reject "overqualified" job applicants - smart workers may be "too hard to manage," because their high outside options make them respond less to .ring incentives. Finally, we extend our model to a dynamic economy with demand shocks and show the following results: Workers entering the labor market in recessions suffer life-long disadvantages in the labor market, temporary demand shocks have long lasting effects on productivity and the composition of the workforce, and moral hazard problems increase in good times for critical sectors in the economy, leading to both higher pay and higher failure rates.

Ulf Axelson and Philip Bond