In an interesting article in the FT, Nassim Nicholas Taleb points out that while the rewards system on Wall Street incentivizes bankers who take risk, it does not have adequate disincentives to discourage a trader whose annual bonuses depends just on the returns he brought in during that period. So while the punt might prove unsuccessful down the line, the banker has already collected his bonuses for the year, and, at worst, only loses his bonus for the year when his long-term punt failed. So, while an entrepreneur lives and dies by the risks he takes (which is the general idea of capitalism), the banker takes the “free option”, so the taxpayer (in some form) is forced to cover the losses.
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Tags: bailout, capitalism, Nassim Nicholas Taleb
isn’t it an entrepreneur ultimately who signs the cheque of his banker-employee to give him his bonus, anyway?
Not necessarily. Who is the entrepreneur at Lehman Brothers? Or Morgan Stanley? These firms have moved beyond that stage, haven’t they?
I don’t consider the term ‘entrepreneur’ to be necessarily a variable of time. While I agree that in a smaller, younger start-up the entrepreneur ‘lives and dies’ by the risks he takes, its equally true for a shareholder in a well established corporation.
Now, my understanding of Nassim’s article leads me to – what is the dis-incentive that caused normally-shrewd and stable risk-taking shareholders to place their money on bankers (assuming the bankers were in the game purely for their bonuses).
Agreed that the shareholder can be treated as an entrepreneur. Her disincentive is that she loses money if her investments go down in value. She does not collect fat bonuses every year. In essence, the shareholder (used an equivalent of “small-time investor”) does not have a “free option”, but the banker does.
We must also note that the banker profits greatly from information asymmetry — a factor that would drive a wedge in our thinking the shareholder can be treated as an entrepreneur, because the latter does not suffer as much IA as the former.