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Currently, the most
important issue with respect to financial institutions is how to motivate staff
without providing perverse incentives. For instance, with the implementation of
a proper incentive system, staff will be motivated via their self-interest to
create financial innovations to better price and hedge risk. However, this
system must also be designed with checks and balances in mind because it is
also very easy to institute a system in which perverse incentives drive individual
behavior. In an effort to modernize the Chinese financial system, it is
important to understand both the underlying mechanism by which people respond
to incentives to better design compensation schemes that maximize innovation.
Utilizing game theory, it is possible to analyze the interplay between these
two drivers of human action. From this analysis it becomes possible to design
better ways of compensating staff to curb undesirable behavior by those in the
financial industry while still promoting innovation within the field.