2014 Nobel Prize winner Jean Tirole and his co-author (Roland
Benabou) have a new paper that addresses some key issues:
“Recent years have seen a literal explosion of pay, both in
levels and in differentials, at the top echelons of many occupations. Large
bonuses and salaries are needed, it is typically said, to retain talent and top
performers in finance, corporations, medicine, academia, as well as to
incentivize them to perform to the best of their high abilities. Paradoxically,
this trend has been accompanied by mounting revelations of poor actual
performance, severe moral hazard and even outright fraud in those same sectors.
Often times these behaviors impose negative spillovers on the rest of society (e.g.,
bank bailouts), but even when not, the firms involved themselves ultimately suffer
large trading losses, declines in stock value, loss of reputation and consumer
goodwill, regulatory fines and legal liabilities, or even bankruptcy.
This paper proposes a
resolution of the puzzle, by showing how competition for the most productive
workers can interact with the incentive structure inside firms to undermine
work ethics the extent to which agents do the right thing beyond what their
material self-interest commands. More generally, the underlying idea is that
highly competitive labor markets make it difficult for employers to strike the
proper balance between the benefits and costs of high-powered incentives. The
result is a bonus culture that takes over the workplace, generating distorted
decisions and significant efficiency losses, particularly in the long run.”