New Delhi, Jan 25 (KNN)  As cinema-goers flock to see "The Wolf of Wall Street", research from Saïd Business School at the University of Oxford shows that encouraging a ‘star’ culture is one of the fastest ways for investment banks to erode their reputation with clients.

Highly skilled and talented young bankers are often keen to make an impression with their employers who offer generous incentives for those who can demonstrate ability.

But a recent study ‘Investment Bank Reputation and “Star” Cultures’ by Professor Alan Morrison at Saïd Business School, Zhaohui Chen and William Wilheim of the University of Virginia, shows performance-based compensation may cause  junior bankers to act in their own self-interests, which are often at odds with those of their clients. This culture gives rise to reputational conflicts, and has contributed to a decline in investment bank reputations in recent years.

‘Investment-banking compensation is especially skewed in favour of “star” bankers, and the incentive for talented junior bankers to prove their ability quickly is further amplified by “up or out” promotion policies,’ said Professor Morrison. ‘Unproven but talented bankers are therefore incentivised to signal their ability through actions that may not best serve their clients and, in so doing, they undermine the institutional reputation.’

It’s not difficult to identify instances in the financial markets in which a banker’s actions might be interpreted as driven, at least in part, by an interest in signalling his or her ability. Matthew Taylor, found guilty of wire fraud for concealing a trade in which Goldman Sachs lost USD 118.4 million claimed to have done so ‘for the purpose of augmenting my reputation at Goldman and increasing my performance-based compensation.’

The challenge to investment banks is to better align ‘the short-term benefit of being perceived as attracting and developing talented employees and the long-term benefit from being perceived as sustaining a culture in which the client’s interest is protected from the incentive distortion facing unproven but talented employees,’ says Morrison.

One solution is to skew the compensation towards senior bankers, weakening the incentive for juniors to take actions that are not in the clients’ best interest. Even here banks need to strike the right balance – set the compensation too high and they run the risk of senior bankers overlooking any potentially high-risk actions of the new recruits if they may personally benefit from them in terms of performance related remuneration.

Another way to tackle this problem is to work very hard to recruit only the most talented people. When investment bankers are already perceived to be very able, their incentive to take damaging actions to signal their competence is reduced. (KNN Bureau)