The Effects of Loan Officers’ Compensation on Loan Approval and Performance: Direct Evidence from a Corporate Experiment

To understand better the role of loan officers in the origins of the financial crisis, we study a controlled experiment conducted by a large bank. In the experiment, the incentive structure of a subset of small business loan officers was changed from fixed salary to commission-based compensation. We use a diffin-diff design to show that while the characteristics of loan applications did not change, commissionbased loan officers are 19% more likely to accept loan applications, and approve loan amounts larger by 23%. Although the observable credit quality of loans booked by commission-based loan officers increased, they were 28% more likely to default. We show that the increase in default occurs primarily at the population of loans that would not have been accepted in the absence of commission-based compensation. Our results show that the explosion in mortgage volume during the crisis and the deterioration of underwriting standards can be partly attributed to the incentives of loan officers.