Recent years have seen a literal explosion of pay, both in levels and in differentials, at the top echelons of many occupations. Large bonuses and salaries are needed, it is typically said, to retain “talent” and “top performers” in finance, corporations, medicine, academia, as well as to incentivize them to perform to the best of their high abilities. Paradoxically, this trend has been accompanied by mounting revelations of poor actual performance, severe moral hazard and even outright fraud in those same sectors.
This paper proposes a resolution of the puzzle, by showing how competition for the most productive workers can interact with the incentive structure inside firms to undermine work ethics.
Inside each firm, agents [i.e., employees] perform both a task that is easily measured (sales, output, trading profits, billable medical procedures) and one that is not. Agents potentially differ in their productivity for the rewardable task and in their intrinsic willingness to provide the unrewarded one—their work ethic.
When skill levels are unobservable [such as soft skills that can't be measured directly], leading firms offer contracts designed to screen different types of workers. (…) Labor-market competition (…) also serves as a device which firms use to attract (or retain) these types.
In short, extremely high executive remuneration attracts people who might possibly be actual top performers but definitely are individuals with extremely high self-confidence. In an extreme case, top managers do not differ from the subordinate employees in the measurable tasks; the difference is in the soft skills only. This may lead to a moral hazard of potentially disastrous dimensions.
As Tirole put it together with his co-author Roland Bénabou:
Competitive bidding for talent is thus destructive of work ethics, and ultimately welfare-reducing.
To put the whole thing in one condensed sentence: If you own a big company and offer too much pay to the top management, you may end up attracting not the best people but the most reckless or selfish ones.
(Well, you may think it's too plain to be a Nobel-worthy idea, but do please read the whole thing:
Bonus Culture: Competitive Pay, Screening, and Multitasking. Roland Bénabou, Jean Tirole. NBER Working Paper No. 18936, Issued in April 2013)