48: Restoring Trust in Finance: From Principal-Agent to Principled Agent
Gordon D. Menzies, Economics Discipline Group, UTS Business School, University of Technology, Sydney; Thomas Simpson, Blavatnik School of Government, University of Oxford; Donald Hay, University of Oxford; David Vines, Department of Economics, Balliol College, St Antony’s College, and Institute for New Economic Thinking (INET) at the Oxford Martin School, University of Oxford; Crawford School of Public Policy, Australian National University; and Centre for Economic Policy Research
Date of publication: July 2018
Working paper number: 48
Abstract: Bonuses in finance represents a bad equilbrium among multiple equilibria. Motivating agents with bonuses can promote untruthfulness, via motivation crowding out, justifying the decision to pay them bonuses. In the equilibrium that works in other professions, moral norms are upheld enough to not require bonuses. Escaping the bad equilibrium is difficult if banks engage in an ‘optimal’ amount of deceit (moral optimization). Restoring trust instead requires that untruthfulness be ruled out a priori (moral prioritization). Reinstating truth telling in finance must contend with a tendency for ethics to be confined to the private domain and motivation crowding out in finance.