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Growth, selection and appropriate contracts

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Abstract

We study a dynamic model where growth requires both long-term investment and the selection of talented managers. When ability is not ex-ante observable and contracts are incomplete, managerial selection imposes a cost, as managers facing the risk of being replaced choose a sub-optimally low level of long-term investment. This generates a trade-off between selection and investment that has implications for the choice of contractual relationships and institutions. Our analysis shows that rigid long-term contracts sacrificing managerial selection may prevail at early stages of economic development and when heterogeneity in ability is low. As the economy grows, however, knowledge accumulation increases the return to talent and makes it optimal to adopt flexible contractual relationships, where managerial selection is implemented even at the cost of lower investment. Measures of investor protection aimed at limiting the bargaining power of managers improve selection under short-term contract. Given that knowledge accumulation raises the value of selection, the optimal level of investor protection increases with development.

Suggested Citation

  • Alessandra Bonfiglioli & Gino Gancia, 2009. "Growth, selection and appropriate contracts," Economics Working Papers 1345, Department of Economics and Business, Universitat Pompeu Fabra, revised Jul 2012.
  • Handle: RePEc:upf:upfgen:1345
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    Cited by:

    1. Clementi, Gian Luca & Cooley, Thomas F. & Wang, Cheng, 2006. "Stock grants as a commitment device," Journal of Economic Dynamics and Control, Elsevier, vol. 30(11), pages 2191-2216, November.
    2. Alessandra Bonfiglioli & Gino Gancia, 2013. "Heterogeneity, selection and labor market disparities," Economics Working Papers 1402, Department of Economics and Business, Universitat Pompeu Fabra, revised Feb 2018.
    3. Alessandra Bonfiglioli & Gino Gancia, 2014. "Growth, Selection and Appropriate Contracts," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 17(1), pages 21-38, January.
    4. Clementi, Gian Luca & Cooley, Thomas F. & Wang, Cheng, 2006. "Stock grants as a commitment device," Journal of Economic Dynamics and Control, Elsevier, vol. 30(11), pages 2191-2216, November.

    More about this item

    Keywords

    information; selection; appropriate contracts; development; growth; appropriate institutions; investor protection.;

    JEL classification:

    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • O40 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - General

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