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 non-linear 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: loan prospecting, screening, and monitoring. We find that when loan officers are at risk of losing their bonuses, they increase prospecting and monitoring. In some specifications, screening also increases. We further show that loan officers adjust their behavior more towards the end of the month when bonus payments are approaching. These effects are more pronounced for loan officers with longer tenures at the bank. Overall, the evidence suggests that the contract is effective for stimulating overall greater effort to extend loans while maintaining loan quality.