A Simple Theory of Managerial Talent, Pay Contracts and Wage Distribution

Yanhui Wu

CEP Discussion Papers from Centre for Economic Performance, LSE

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.

Keywords: Managerial Talent; Limited Liability; Provision of Incentives; Pay Structure; CEO Pay; Wage Distribution (search for similar items in EconPapers)
JEL-codes: D2 J3 L1 L2 M5 (search for similar items in EconPapers)
Date: 2011-08
New Economics Papers: this item is included in nep-bec, nep-cta, nep-ent, nep-hrm, nep-lab and nep-lma
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

Downloads: (external link)
https://cep.lse.ac.uk/pubs/download/dp1067.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cep:cepdps:dp1067

Access Statistics for this paper

More papers in CEP Discussion Papers from Centre for Economic Performance, LSE
Bibliographic data for series maintained by ().