A simple theory of managerial talent, pay contracts and wage distribution

Wu, Yanhui (2011) A simple theory of managerial talent, pay contracts and wage distribution. CEP Discussion Papers (CEPDP1067). London School of Economics and Political Science. Centre for Economic Performance, London, UK.

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Abstract

This paper develops a simple theory of pay structures and pay levels across heterogeneous agents by bringing together optimal contracts inside the firm and competitive resource allocation in the market. The central idea is that more talented people tend to create greater value but face larger conflicts of interest in their employment relationship, and different pay contracts are optimally designed to mitigate different levels of agency problems. Sorted by their talent, people are stratified into production workers, self-employed, salaried managers with low-powered performance pay, and CEOs with high-powered equity-based pay. In a general equilibrium framework, I show that the sorting of managerial talent into pay contracts is tied to firm size. The theory highlights that high-powered incentive pay and large scales of operations cause the disproportionately large wage earnings at the top, and are the main source of income inequality. Market forces that reallocate resources from smaller to larger firms tend to increase the threshold talent for becoming a manager, increase the prevalence of high-powered incentive pay, raise the top earnings, and spread out the wage distribution.

Item Type:	Monograph (Discussion Paper)
Official URL:	https://cep.lse.ac.uk/_new/publications/discussion...
Additional Information:	© 2011 The Author(s)
Divisions:	LSE
Subjects:	H Social Sciences > HC Economic History and Conditions H Social Sciences > HD Industries. Land use. Labor > HD28 Management. Industrial Management
JEL classification:	D - Microeconomics > D2 - Production and Organizations J - Labor and Demographic Economics > J3 - Wages, Compensation, and Labor Costs L - Industrial Organization > L1 - Market Structure, Firm Strategy, and Market Performance L - Industrial Organization > L2 - Firm Objectives, Organization, and Behavior M - Business Administration and Business Economics; Marketing; Accounting > M5 - Personnel Economics
Date Deposited:	26 Feb 2024 15:12
Last Modified:	11 Dec 2024 19:52
URI:	http://eprints.lse.ac.uk/id/eprint/121904

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