Process Intangibles and Agency Conflicts

Abstract

Intangible capital can be used to create new goods and services (product intangibles) or to improve the efficiency of the firm (process intangibles). We reveal and study a new empirical fact: Executive and skilled labor pay is increasing in firm process intensity (the fraction of intangibles corresponding to process intangibles). We rationalize this fact in a dynamic principal-agent model. The optimal contract reveals a direct and indirect effect of process intensity on compensation. The direct effect is a level effect: Higher process intensity increases the returns to shirking. The indirect effect is a slope effect: Higher complementarity between process intangibles and physical capital investment increases the hold up power the agent has over the firm for any level of process intensity. We verify these effects in the data. Importantly, we show that these effects are present in executive compensation and in the wages of highly skilled innovative employees, which we are able to measure using proprietary granular vacancy posting data from a labor-market data firm. In our baseline specification, a one standard deviation increase in process intensity is associated with an 8% increase in executive pay and a 3% increase in skilled labor wages relative to industry peers.

Keywords: Process Intangibles, Intangible capital, Dynamic contracting, Compensation

JEL Classification: D21, E22, G31, G32, L22, O31, O34