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

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  • Yanhui Wu

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.

Suggested Citation

  • Yanhui Wu, 2011. "A Simple Theory of Managerial Talent, Pay Contracts and Wage Distribution," CEP Discussion Papers dp1067, Centre for Economic Performance, LSE.
  • Handle: RePEc:cep:cepdps:dp1067
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    File URL: http://cep.lse.ac.uk/pubs/download/dp1067.pdf
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    References listed on IDEAS

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    Cited by:

    1. Yanhui Wu, 2011. "Managerial Incentives and Compensation in a Global Market," CEP Discussion Papers dp1066, Centre for Economic Performance, LSE.

    More about this item

    Keywords

    Managerial Talent; Limited Liability; Provision of Incentives; Pay Structure; CEO Pay; Wage Distribution;

    JEL classification:

    • D2 - Microeconomics - - Production and Organizations
    • J3 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs
    • L1 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance
    • L2 - Industrial Organization - - Firm Objectives, Organization, and Behavior
    • M5 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Personnel Economics

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