DP8905 | Seeking Alpha: Excess Risk Taking and Competition for Managerial Talent

Publication Date

01/03/2012

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Abstract

We present a model of labor market equilibrium in which managers are risk-averse, managerial talent (?alpha?) is scarce, and firms seek alpha, that is, compete for this talent. When managers are not mobile across firms, firms provide efficient long-term compensation, which allows for learning about managerial talent and insures low-quality managers. In contrast, when managers can move across firms, high-quality managers can fully extract the rents arising from their skill, which prevents firms from providing co-insurance among their employees. In anticipation, risk-averse managers may churn across firms before their performance is fully learnt and thereby prevent their efficient choice of projects. The result is excessive risk-taking with pay for short-term performance and build up of long-term risks. We conclude with analysis of policies to address the resulting inefficiency in firms' compensation.