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Ability and agency costs: evidence from Polish banking

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Theory and evidence suggest that performance-based pay can increase productive effort but may also give rise to distorted effort choices (multitasking or “gaming”). Performance-based pay is often coupled with delegation of broad decision-making authority. Much existing work assumes that the gains to delegation are increasing in the agent’s (cognitive) ability. However, this work does not address the possibility that such ability may be correlated with agents’ ability to game their incentive plans. In certain settings, agency losses from ability could outweigh the productivity gains. We investigate this possibility using data from a large Polish retail bank. We find that branch managers select the interest rate and size of consumer loans in a manner consistent with gaming of their incentive plan. Furthermore, evidence of this gaming behavior is stronger for managers with a better understanding of their incentive plan. Finally, we estimate that the bank loses between three and twelve percent of its profits from managers’ pricing decisions and that the losses are greater for the moreknowledgeable managers. We estimate these agency costs through a novel empirical strategy, using managers’ position in their incentive plan as a supply shifter to identify the bank’s demand for loans.

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