Financial incentives and loan officer behavior: multitasking and allocation of effort under an incomplete contract

Abstract

We investigate the implications of providing loan officers with a compensation structure that rewards loan volume and penalizes poor performance. Using a unique data set provided by a large international commercial bank, we examine the three main activities that loan officers perform: monitoring, origination, and screening. We find that when loan officers are at risk of losing their bonus, they increase monitoring and origination, but not screening effort. On the other hand, having lost a bonus in the previous period does not entail higher effort. We document unintended consequences of the incentive contract showing the incompleteness of such contracts.