Quoting the Crisis

Investment banking is a demanding job. “Rainmakers” typically work long hours under high stress. Yet the number of highly qualified graduates from top colleges eager to enter investment banking has typically far exceeded the demand. Why hasn’t the excess of supply over demand failed to drive earnings down?

The importance of personal networks and contacts gives rainmakers leverage. As the Nobel laureate Oliver Williamson emphasizes, the threat of withdrawing from or disrupting productive relationships can give employees considerable power. The apprenticeship structure of the job gives senior managers and traders control over their successors.

The very qualities that contribute to success on the trading floor — including aggressive use of technical expertise — may be deployed in joint efforts to reduce competition from new job entrants or to weed out those unlikely to demand super-high compensation.

In any case, highly paid employees in finance earn large premiums compared to their counterparts in other industries — pay differences that persist even when virtually all measurable differences in individual characteristics are taken into account. A recent National Bureau of Economic Research paper by Thomas Philippon and Ariell Reshef describes such premiums as unearned “rents.”