Technological change and the growing inequality in managerial compensation

• Published in: Journal of financial economics 2011-03, Vol.99 (3), p.601-627
• Main Authors: Lustig, Hanno, Syverson, Chad, Van Nieuwerburgh, Stijn
• Format: Article
• Language: English
• Subjects: Capital structure; Compensation; Corporate payout policy; Corporate payout policy Organizational capital Labor reallocation Managerial compensation Pay-for-performance sensitivity; Earnings; Economic models; Executive compensation; Financial performance; Income inequality; Inequality; Labor market; Labor reallocation; Managerial compensation; Organization theory; Organizational capital; Pay for performance; Pay-for-performance sensitivity; Senior management; Studies; Technological change
• ISSN: 0304-405X; 1879-2774
• DOI: 10.1016/j.jfineco.2010.09.007

Three of the most fundamental changes in US corporations since the early 1970s have been (1) the increased importance of organizational capital in production, (2) the increase in managerial income inequality and pay-performance sensitivity, and (3) the secular decrease in labor market reallocation. Our paper develops a simple explanation for these changes: a shift in the composition of productivity growth away from vintage-specific to general growth. This shift has stimulated the accumulation of organizational capital in existing firms and reduced the need for reallocating workers to new firms. We characterize the optimal managerial compensation contract when firms accumulate organizational capital but risk-averse managers cannot commit to staying with the firm. A calibrated version of the model reproduces the increase in managerial compensation inequality and the increased sensitivity of pay to performance in the data over the last three decades. This increased sensitivity of compensation to performance provides large, successful firms with the glue to retain their managers and the organizational capital embedded in them.