Technological Change and the Growing Inequality in Managerial Compensation

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. ∗We are grateful to Jason Faberman, Carola Frydman, Enrichetta Ravina, and Scott Schuh for generously sharing their data with us. Lorenzo Naranjo and Andrew Hollenhurst provided outstanding research assistance. For helpful comments we would like to thank Andy Atkeson, Jonathan Berk, Nick Bloom, Murray Carlson, Xavier Gabaix, Ron Giammarino, Francois Gourio, Fatih Guvenen, Hugo Hopenhayn, Boyan Jovanovic, Arvind Krishnamurthy, Adriano Rampini, Kjetil Storesletten, and participants at the UCL conference on income and consumption inequality, the NBER Asset Pricing meetings in Cambridge, the Western Finance Association in Hawaii, Society for Economic Dynamics in Cambridge, the CEPR conference in Gerzensee, the AEA Meetings in San Francisco and seminar participants at Duke finance, NYU Stern finance, HBS finance, UBC finance, Wharton finance, INSEAD finance, Stanford economics, Kellogg finance, and the NYU macro lunch. This work is supported by the National Science Foundation under Grant No 0550910.