Risky Investments with Limited Commitment
Over the last three decades there has been a dramatic increase in the size
of the financial sector and in the compensation of financial executives.
This increase has been associated with greater risk-taking and the use of
more complex financial instruments. Parallel to this trend, the
organizational structure of the financial sector has changed with the
traditional partnership replaced by public companies. The organizational
change has increased the competition for managerial talent and
weakened the commitment between investors and managers. We show how
the increased competition and the weaker commitment can raise the managerial
incentives to undertake risky investment. In aggregate, this
results in higher risk-taking, a larger and more productive financial
sector, greater income inequality, and lower market valuation of financial institutions.