‘Since You’re So Rich, You Must Be Really Smart’: Talent and the Finance Wage Premium

Research Retrieved: April 2018
Retrieve the paper from SSRN

Issue

Wages in the financial sector have experienced an extraordinary increase over the last few decades. In Sweden, the country the authors study, average earnings of finance employees rose from 120% of average private sector earnings in 1990 to almost 170% in 2014.
In a competitive labor market, wages should rise if the marginal productivity of workers increases. A leading explanation for the surge in finance pay has thus been that finance workers have become relatively more productive compared to other sectors over this period.
The authors use Swedish administrative data, which include detailed cognitive and non-cognitive test scores as well as educational performance, to examine the implications of this hypothesis for talent allocation and relative wages in the financial sector.

Key Findings

The authors find no evidence that the selection of talent into finance has improved, neither on average nor at the top of the talent and wage distributions. Thus, a “brain drain” from other sectors into the financial sector cannot explain the finance wage premium. Results rather suggest that finance workers capture substantial and over time increasing rents.
Finance workers more talented, but unchanged since 1990: the authors find that finance workers are more talented on average, yet talent levels in finance did not improve since 1990.

  • Talent has not become more important: the authors find no evidence that talent has become a more important determinant in the decision to enter the finance industry.
  • The finance wage premium unrelated to talent: talent and earnings are significantly positively related in all industries. But increasing wages in the finance industry cannot be explained by higher talent levels. The finance wage premium exists for higher-talent and for lower-talent individuals.
  • Entire finance industry benefits: the relative compensation has risen in almost all the 30 most common occupations in finance regardless of skill requirements, income level, or relative talent among workers holding these jobs.

 

Practical Relevance

The authors present strong evidence for the causes and consequences of the increasing relative compensation in the financial industry. Their results suggest that competition for talent is not a main cause of the increase in relative finance wages over the last three decades, and that the increase in finance wages is unlikely to have caused negative externalities on the supply of talent to other sectors.

Their result rather points towards other explanations for the increase of relative compensation in finance, such as increasing excess profits in the sector, which in turn are being shared with workers, e.g., because of moral hazard reasons, fairness concerns, or poor governance.