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CEP discussion paper
Managerial Incentives and Compensation in a Global Market
Yanhui Wu
August 2011
Paper No' CEPDP1066:
Full Paper (pdf)

JEL Classification: D2; F1; J3; L1

Tags: trade; heterogeneous firms; pay contracts; managerial incentives; managerial compensation; wage inequality

This paper embeds a principal-agent firm in an otherwise standard trade model a la Melitz (2003) to investigate the impact of globalization on the provision of managerial incentives and on the distribution of managerial compensation. Facing contractual frictions due to limited liability, firms with heterogeneous productivity endogenously sort into different pay structures to mitigate different levels of agency problems. More productive firms use a higher-powered incentive contract while less productive firms use a lowered- powered one. International trade within an industry enhances market competition, inducing resources reallocated from low productivity domestic firms to high productivity exporting .rms. The uneven effects of international trade on firms that differ in their exporting status and pay structure result in more prevalence of high-powered incentive pay, a larger wage gap between managers and production workers, and a higher level of wage inequality among managers.