Managerial Turnover

In an environment where managers’ability to generate pro…ts changes stochastically over time, we characterize the optimal turnover policy for a …rm hiring a succession of managers. The focus is on the interaction between the compensation scheme used to incentivize the managers’e¤ort and the retention policy used to screen the managers’types and induce the desired turnover. Our key positive result shows that the …rm’s optimal retention policy becomes gradually more permissive over time: the productivity level that the …rm requires to an incumbent manager to be retained declines with the manager’s tenure in the …rm. This result helps explain the practice of rewarding managers that are highly productive at the early probatory stages (and hence generate, on average, high pro…ts) by o¤ering them job stability once their tenure in the …rm becomes long enough. Our key normative result shows that, when compared to what is e¢ cient, the …rm’s pro…t-maximizing contract either induces excessive retention (i.e., ine¢ ciently low turnover) throughout the entire relationship, or excessive …ring at the early stages followed by excessive retention in the long run. JEL classi…cation: D82