Promotion, Turnover, and Compensation in the Executive Labor Market

This paper constructs and estimates a generalized Roy model with human-capital accumulation and moral hazard to control for self-selection by executives across firms and jobs. It uses the estimated model to decompose the firm-size pay gap into five sources, namely: (1) utility from working, (2) divergence in incentives, (3) monitoring, (4) demand, and (5) human-capital accumulation. It finds no support for (1), because although total compensation and incentive pay increase with firm size, the certainty-equivalent wage decreases with firm size. The risk premium paid to correct ineffi ciencies caused by (2) and (3) accounts for roughly more than 80 percent of firm-size total-compensation gap, while (4) accounts for the rest. The quality of the signal about effort is unambiguously poorer in larger firms, which completely explains the larger risk premium. While human capital from formal education and experience gained from different firms are individually significant, collectively their effect on the firm-size pay differentials nets out.