Information Technology and the Growing Inequality in Managerial Compensation

Three of the most fundamental changes in US corporations since the early 1970s have been (1) the apparent increase in the 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, brought about by the arrival and gradual adoption of information technology since the 1970s. 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 in the match. 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. In addition, we show that firms in industries with less vintage-specific growth and hence more more compensation inequality have higher Tobin’s q, as predicted by our model. ∗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, Fatih Guvenen, Hugo Hopenhayn, Boyan Jovanovic, 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, and seminar participants at Duke finance, NYU Stern finance, HBS finance, UBC finance, Wharton finance, Stanford Economics and the NYU macro lunch. This work is supported by the National Science Foundation under Grant No 0550910.