Compensating Financial Experts

We propose a labor market model in which financial firms compete for a scarce supply of workers who can be employed as either bankers or traders. While hiring bankers helps create a surplus that can be split between a firm and its trading counterparties, hiring traders helps the firm appropriate a greater share of that surplus away from its counterparties. Firms bid defensively for workers bound to become traders, who then earn more than bankers. As counterparties employ more traders, the benefit of employing bankers decreases. The model sheds light on the historical evolution of compensation in finance.