Finance Salaries, Returns-to-talent and Inequality

Many people believe that the finance sector is contributing disproportionately to income inequality in our society. Do you agree?

I do. Ever since the 1980s, compensation in finance has been higher and more skewed than in other sectors. It has been shown that the ‘finance wage premium’ — the degree to which finance salaries exceed those in other industries — is, on average, 50 per cent. That is why the sector has been criticized as one of the sources of growing income inequality.

My colleagues and I felt that this public debate called for an improved understanding of the drivers of bankers’ pay. Our intuition told us that one of the key drivers is the competition for talent. For our research, we defined talent as, ‘the aptitude to reach an objective in a competitive environment’. In this definition, talent encompasses not only cognitive skills, but also personality traits such as motivation, self-discipline, low cost of effort, and ability to perform in a competitive environment. We set out to answer two questions: Are wage returns to talent relatively high in finance compared to the rest of the economy?; and, Do talent effects drive the cross-section of wages observed in finance?

Our main finding was that the finance wage premium has indeed been disproportionately allocated to the most talented individuals in this sector: returns to talent were three times higher in finance than in the rest of the economy. We also discovered that, while wages have increased a lot in the finance sector overall, they have increased even more for the top percentile in the sector. The most talented individuals in finance have thus received most of the available wage increases in recent decades. We believe these significant returns are also associated with an increasing share of talented individuals choosing to go into finance occupations.

Our results contribute to the overall understanding of the well-documented rise in income equality. While these outcomes may be both meritocratic and economically efficient in the short run — they might not be socially or politically sustainable in the long run.

Within finance, you found that returns-to-talent for ‘front-office’ jobs are even higher when compared to back office or ‘support’ departments. Please discuss this finding.

We found that indeed, returns to talent are higher for frontoffice jobs like traders or quants, relative to ‘back-office’