Rankings and risk-taking in the
finance industry.
Michael Kirchler, Florian Lindner,
Utz Weitzel
Working Papers in Economics and Statistics
2016-02
University of Innsbruck
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Rankings and Risk-Taking in the Finance Industry
∗
Michael Kirchler, Florian Lindner and Utz Weitzel
†
September 14, 2017
forthcoming in: Journal of Finance
Abstract
Rankings are omnipresent in the finance industry, yet there is no research how they
impact financial professionals’ behavior. We run lab-in-the-field experiments with 657 pro-
fessionals and lab experiments with 432 students to investigate how rank incentives affect
investment decisions. We find that both rankings and tournament incentives increase risk-
taking among underperforming professionals, but rankings do not affect students. We show
that the rank-effect is robust to the experimental frame (investment frame versus abstract
frame), to payoff consequences (own return versus family return), to social identity prim-
ing (private identity versus professional identity), and to professionals’ gender (no gender
differences among professionals).
JEL: G02, G11, D03, C93
Keywords: Experimental finance, behavioral finance, rank incentives, rankings, financial
professionals, social identity theory, lab-in-the-field experiment, tournament incentives.
∗
We are grateful to the Editor Bruno Biais, one Associate Editor, and two anonymous referees for excellent
and constructive comments during the editorial process. We thank Loukas Balafoutas, Gary Charness, Alain
Cohn, Oege Dijk, Florian Englmaier, Sascha Füllbrunn, Cary Frydman, Maximilian Germann, Fabian Herweg,
Jürgen Huber, Michel Andre Marechal, Peter Martinsson, Kurt Matzler, Stefan Palan, David Porter, Jianying
Qiu, Stephanie Rosenkranz, David Schindler, Simeon Schudy, Joep Sonnemans, Rudi Stracke, Matthias Stefan,
Matthias Sutter, Alexander Wagner, Janette Walde, Erik Wengström, Stefan Zeisberger, seminar participants
at the Universities of Bergen, Innsbruck, Lund, Munich, Nijmegen, London, Salzburg, Trento, Trier, Utrecht, as
well as conference participants at the AEA Annual Meeting 2017 in Chicago, Hållbara Finanser in Stockholm
2017, Status and Social Image Workshop (WZB) 2017 in Berlin, Experimental Finance 2017 in Nizza, Research
in Behavioral Finance Conference 2016 in Amsterdam, Behavioral Economics of Financial Markets Workshop in
Zurich 2016, EFA 2016 in Oslo, ESA 2016 in Bergen, ESA 2015 in Heidelberg, Experiment a BIT 2015 in Trento,
Experimental Finance 2015 in Nijmegen, and eeecon Workshop 2015 in Innsbruck for very valuable comments.
We are grateful to Michael Dünser, Achiel Fenneman, Felix Holzmeister, Dirk-Jan Janssen, Patricia Leitner, Fritz
Pöllmann, Melanie Prossliner, Lorenz Titzler, Alexander Wolf, and Jan Zatocil for excellent research assistance.
We particularly thank Rani Piputri and all financial institutions and participating professionals for the excellent
collaboration. Financial support from the Austrian Science Fund (FWF START-grant Y617-G11 and SFB F63),
Radboud University, and the Swedish Research Council (grant 2015-01713) is gratefully acknowledged. This
study was ethically approved by the IRB of the University of Innsbruck. All three authors declare that they have
no additional relevant or material financial interests that relate to the research described in this paper.
†
All authors contributed equally. Kirchler: Corresponding author. University of Innsbruck, Department
of Banking and Finance, Universitätsstrasse 15, 6020 Innsbruck, and University of Gothenburg, Department
of Economics, Centre for Finance, Vasagatan 1, 40530 Gothenburg. Phone: +43 512 507 73014, E-mail:
michael.kirchler@uibk.ac.at. Lindner: University of Innsbruck, Department of Banking and Finance, Univer-
sitätsstrasse 15, 6020 Innsbruck. Phone: +43 512 507 73008, E-mail: florian.lindner@uibk.ac.at. Weitzel: Utrecht
University School of Economics, Kriekenpitplein 21-22, 3584 EC Utrecht, E-mail: u.weitzel@uu.nl; Radboud Uni-
versity, Institute for Management Research, Thomas van Aquinostraat 5.1.26, 6525 Nijmegen.
1
In recent years, excessive risk-taking in the finance industry has been depicted as one of the
main contributors to the global financial crisis (Financial Crisis Inquiry Commission, 2011; De-
watripont and Freixas, 2012). In particular, bonus schemes and tournament incentives have
been identified among the main drivers for excessive risk-taking in developed financial markets
(Rajan, 2006; Diamond and Rajan, 2009; Bebchuk and Spamann, 2010). These tournament
incentives are characterized by two major components. The first and more obvious compo-
nent is that salary and other material rewards depend on performance, creating rank-dependent
“monetary incentives” for outperforming others. The second and less obvious component con-
sists of “non-monetary incentives” to do better than peers. This second component—called
“rank incentives”—provides utility to those at the top of the ranking and disutility to those
at the bottom (Barankay, 2015), representing preferences for relative performance.
1
This non-
monetary preference for relative performance can be driven by the desire for a positive self-image
(Bénabou and Tirole, 2006; Köszegi, 2006), but also by concerns about public status (Frank,
1985; Moldovanu et al., 2007). Hence, rank incentives not only have an implicit relevance in
tournaments, but also play a more prominent, explicit role. In the finance industry, rankings,
ratings, and awards are the visible hallmarks of a strong culture of relative performance and
social competition. Funds are ranked or rated annually and so are their managers.
2
Awards
to the “Fund Manager of the Year”, the “Banker of the Year”, or the “Analyst of the Year” are
recurring and sought-after distinctions in many areas of finance.
3
More informally, financial pro-
fessionals (henceforth professionals) often compare themselves with others in their discussions
about investments and their successes (“cheap talk”, see Crawford, 1998), effectively ranking
each other on a permanent basis. Recent evidence from laboratory and field experiments doc-
uments that rank incentives, on average, increase individuals’ effort and performance (Azmat
and Iriberri, 2010; Blanes-i-Vidal and Nossol, 2011; Tran and Zeckhauser, 2012; Bandiera et al.,
2013; Delfgaauw et al., 2013), but also promote unethical behavior (Charness et al., 2014).
In an industry where competition and relative performance take center stage, it is striking
that no scientific evidence exists showing how competition for rank affects professionals’ behavior.
This study narrows this gap by investigating the impact of rankings on professionals’ risk-taking
in investment decisions. We conducted lab-in-the-field experiments and online experiments with
657 financial professionals from major financial institutions in various OECD countries and labo-
ratory experiments with 432 students. Importantly, we only recruited professionals who regularly
engage in investment decisions in their professional life. The experiments differ in the selection
of participants (professionals versus students), in the frame the investment decisions were made
1
See Veblen (1899) and Festinger (1954) for classical papers and Roussanov (2010) for a finance application.
2
See, for example, http://www.morningstar.com/; http://money.usnews.com/funds/mutual-funds;
http://www.bloomberg.com/news/articles/2014-01-08/glenview-s-robbins-tops-hedge-fund-ranking-with-bet-on-
obamacare.
3
See, for example, http://www.fmya.com/; http://www.investmentawards.com;
http://excellence.thomsonreuters.com/award/starmine.
2
(investment frame versus abstract lottery frame), in the payoff consequences (own return versus
family return), in professionals’ social identity that was made salient (private identity versus
professional identity), and whether the ranking was payoff-relevant (non-incentivized ranking
versus tournament incentives). This allows us to draw a comprehensive picture of the role of
rankings in professionals’ risk-taking behavior.
In the first experiment, PROF, we investigate whether and to what extent non-incentivized
rankings and tournament incentives drive professionals’ risk-taking in framed investment de-
cisions. For this, we recruited 252 professionals and administered repeated portfolio choices
between a risk-free alternative and a risky asset for eight periods. In the baseline treatment pro-
fessionals faced linear incentives and were paid according to their final wealth. In the ranking
treatment everything was kept identical but, in addition, participants received feedback on their
position in an anonymous ranking among peers. The ranking itself was not payoff-relevant. We
find that, compared to the baseline, significantly more risk is taken among underperformers when
an anonymous and non-incentivized ranking is displayed. We also administered a tournament
treatment which was identical to the ranking treatment except that the ranking was relevant for
payout. In line with literature on bonuses and risk-taking (e.g., Rajan, 2006; Kleinlercher et al.,
2014), we find that average risk-taking of professionals increases with tournament incentives
compared to the baseline. This increase in risk-taking is mainly driven by underperformers.
When zooming in on rank-dependent risk-taking, our data suggest that rank incentives shape
risk-taking in the tournament treatment. In fact, monetary incentives in the tournament treat-
ment hardly change rank-dependent risk-taking we already observe in the ranking treatment.
This indicates that, solely by displaying a non-incentivized ranking, professionals’ concerns for
relative performance are activated, often at tournament level.
If concerns for relative performance are universal in framed investment decisions, one could
expect that rank-driven behavior is equally strong among professionals and non-professionals.
Hence, in a second experiment, STUD, we analyze whether results hold with a sample of 432
students who obviously have no financial professional identity. We kept the experiment identical
in treatments and design (except for lower stakes). We observe fundamentally different results as
students’ risk-taking in the ranking treatment is not driven by rank incentives. In the tournament
treatment, however, incentivized rankings increase risk-taking among underperformers similarly
to the professionals.
These findings raise the question about the origins and the robustness of behavioral differ-
ences between industry professionals and non-professionals. One candidate explanation is that
professionals might import their professional identity and experience from years in the industry
to the laboratory. According to social identity theory of Akerlof and Kranton (2000) decision
makers have multiple social identities (e.g., gender, ethnicity, or occupation) prescribing how
they behave when a certain identity is salient. Behavior is influenced because individuals ex-
perience a disutility if their behavior deviates from what their identities specify. Cooper et al.
3
