Letters to the Editor

Survival of the fittest

In "Risky Business" (September 2005), Raghuram Rajan argues that skewed incentives for investment managers may be adding to global financial risks. As savings have been disintermediated and increasingly channeled toward investment managers and away from banks, risks have increased because investment managers have a higher incentive to take risk. The key to his argument is that investment managers-as opposed to bank managers-face a compensation structure with a large upside and little downside, thus skewing their investment decisions toward riskier behavior.

I would like to disagree. Taking it to the extreme, there are two types of incentive structures. On the one hand, bank managers receive a large salary and a small bonus based on the general profitability of their company. Failing performances do not lead to serious punishment, for they are blurred into the overall results of the bank. On the other hand, absolute return high risk investment managers receive a proportionally smaller salary and a larger bonus based on individual performance. The investment manager can reap the profits of a successful performance, but he or she can also lose everything in a failing performance and be out of a job. Absolute return investment managers thus play a continuous survival game, where the key objective is to be able to play the following day. These pressures are what introduce discipline into their actions, resulting in profit maximization.

The symmetric definition of limited liability places absolute return investment managers in a superior risk-reward position. Relative return investment managers (for instance, mutual fund managers) do not face this structure, though, and may be closer to the skewed incentive structure that Mr. Rajan comments on and finds problematic.

Angel Ubide

Research Fellow Center for European Policy Studies, Brussels

Who should pay for university?

Nicholas Barr ("Financing Higher Education," June 2005) reminded us that graduates earn a large private return to their degrees. It is, therefore, right that these graduates contribute more to the costs of their higher education. Why should low wage taxpayers (whose children do not attend higher education) subsidize the children of wealthier families who do go to university? Certainly poorer students are much less likely to get a degree, as compared to richer...