Seeking Alpha: Excess Risk Taking and Competition for Managerial Talent

Abstract

We present a model of labor market equilibrium in which managers are risk- averse, managerial talent (\alpha") is scarce, and rms seek alpha, that is, compete for this talent. Firms provide ecient long-term compensation, which allows for learning about managerial talent and assigning of managers to tasks based on their talent, when managers are not mobile across rms. In this case, rms can insure low-quality managers since high-quality managers have limited outside options. In contrast, when managers can move across rms, high-quality managers can fully extract ex post the rents due to their skill, which prevents rms from providing co-insurance among their employees. In anticipation, risk-averse managers may churn across firms before their perfor- mance is fully learnt and thereby prevent their efficient assignment to tasks. The result is excessive risk-taking with pay for short-term performance and build up of long-term risks. As the model is suited for the financial sector, we conclude with analysis of policies to address the externality in compensation among financial firms.