The Economics of Super Managers

Abstract:     
We study a competitive model in which firm managers differ in terms of ability, and the managers’ actions are private information. Each firm chooses how able a manager to hire, and optimizes the manager’s incentive pay as well as the level of cooperating resources available to the manager. Thus, firm size, managerial talent, and incentives are simultaneously determined in equilibrium. The model can be considered as an amalgam of agency and Superstars, in which the possibility to adjust incentives enhances the firm’s ability to provide a more talented manager with greater cooperating resources, and the ability to adjust cooperating resources enables better incentives. For example, the convexity of firm size as a function of the ability of the manager, the focus of the Superstars model, is increased when incentives are optimized. We study both a homogeneous firm model and a heterogenous firm extension, and find that our results are generally stronger when managers and firms match assortatively by managerial ability and firm productivity. The model delivers many testable implications. Some preliminary empirical results show the model is useful for understanding interesting compensation trends, e.g., CEO pay has recently become more closely associated with firm size. In the model, a closer association is the outcome of demand growth (and/or an inflow of workers). In the twelve Fama-French industries, the industries in which the association between CEO pay and size has increased are also those for which industry sales growth has been greater.

Number of Pages in PDF File: 57

Keywords: CEO compensation, incentive pay, product market, labor market, equilibrium

JEL Classification: J33, G8, G32, G34, L11, M52

working papers series