Per Strömberg Interview: "Since you're so rich, you must be really smart.."

We're trying to address a big issue, which is why compensation and wages in finance have increased so much more compared to other sectors over a long period of time—the last three decades or something. We don't have the answer; I guess the research asks more questions than it answers. We hone in on a particular explanation of this, which you hear both from academics as well as practitioners, which is that we have to pay higher and higher salaries because it's harder and harder to get the talent we need into the finance industry. And so actually, another version, the more nerdy version of this, is that the productivity of the most talented people has been increasing faster in finance than other sectors. So we test that explanation and basically find no support for that particular explanation.

There are two pieces of information, two pieces of data, that goes against this. The one piece of data is that the average talent of people working in the finance industry is pretty much constant over time. So if the demand for talent would be increasing because these people are more productive, then you would see the fraction of talented people going up, but we don't see that. It's pretty constant over time, and we have talent measures like IQ, social skills, leadership skills, school grades, and for none of these features do you see any increase in talent in finance.

The other thing we find is that the salary increases have not just been happening for the most talented people, but it's actually been happening pretty much across the board. So if you were a doorman working in finance, you make about 50 percent more money than if you're a doorman working for a non-financial company, and that wedge has been increasing remarkably over time.

So I think the takeaway—and this is where we're going next with this—is okay, so if it's not competition for talent driving this wage gap, what is it? And one of the things we already looked at is risk. So some people may say that finance has become more risky or less pleasant of a job over time. We find no support for that either. People work a lot in investment banking, but they worked as much in the 1990s as they did in 2010.

We find that finance, okay, on the one hand, it's a riskier job in the sense that the distribution of compensation is wider, if you will. So if you look at the three-year wage growth of someone working in finance compared to the three-year wage growth for someone not working in finance, you see a wider distribution if you work in finance. So that would be risk.

But what goes against that is that there's very little downside risk in the finance pay, but there's a lot of upside risk—or upside gain, potentially—in finance, and that's really what drives just higher variability. So the reason why it looks like finance pays more for risk is that you have a higher likelihood of getting big, big raises. But if you look at the pay cuts, you're actually somewhat less likely to get a big pay cut in finance compared to other sectors. So it can't be risk.

So now we're looking at things like rent sharing. Information holds some promise because we've seen in other sectors of the economy that the amount you pay people working in your firm is very correlated with the profitability of your firm—which may seem very natural for everyone, maybe except economists, because we would say that you should be paid your marginal productivity, and your outside option is not clear you get this correlation from there. But that's what you see. For example, labor economists have shown that within-firm pay inequality is much lower than across-firm pay inequality.

So we feel that one of the explanations, if you want to call it that, or final space, is that banks are becoming more profitable, and people working for these banks get some constant share of the spoils or the profits. Well, that is basically what's going on, regardless of how talented or productive they are.

I think people at the end of the day are not very surprised or seem convinced. And actually, the people who seem easier to convince are people working in the sector, as opposed to academics. Academics are often more skeptical of the results, but people working in the sector are less so.

One prominent person I know working in investment banking—his gut reaction was, 'No, it doesn't surprise me at all. There are so many mediocre, overpaid people in our sector.' That was his immediate reaction. Another person I know who works in top management at one of the big Swedish banks said, 'Well, I've been thinking about who makes the most money at our bank, and it's not the smartest people, it's not the nicest people.' So this would be consistent with our result. So who is it? Well, I think it's the people who really, really like to make money—and that would maybe be the skill that we can't measure that drives the high wages in finance. Who knows? But anyway, I've gotten very interesting and kind of positive response from people in the sector.

I was lucky enough to become involved with the CGI quite early on, and it's been a terrific, terrific relationship to have. The conferences have been stellar, and I think someone earlier today mentioned that one of the nice things is bringing economists and finance people on the one hand and lawyers together in a common forum where we actually talk to each other. And that kind of multiplier effect you get from putting these two perspectives together—it's been terrific and it really works. So I'm very impressed.