Globalization and the Provision of Incentives Inside the Firm: The Effect of Foreign Competition

Abstract

This paper studies the effect of changes in foreign competition on the incentives faced by U.S. managers in the form of wage structures, promotion premia, and job turnover. We use a panel of executives and measure foreign competition as import penetration. Using tariffs and exchange rates as instrumental variables, we estimate the causal effect of globalization on the labor market outcomes of these workers. We find that higher foreign competition leads to more incentive provision in a variety of ways. First, it increases the sensitivity of pay to performance and it does so more the higher up the executive is in the firm hierarchy. Second, it raises the return to a promotion and increases pay inequality among the top executives of the firm, with CEOs typically experiencing the largest wage increases, partly because they receive the steepest incentive contracts. Third, we show that higher foreign competition also is associated with a higher demand for talent at the top of the firm. Finally, higher competition is associated with a higher probability of leaving the firm. These results indicate that increased foreign competition can explain some of the recent trends in compensation structures.