Corporate Governance, Favoritism and Careers

Abstract

Careers are often shaped by favoritism even though this saps firm performance. If controlling shareholders trade off private benefits from favoritism against its efficiency costs, the quality of corporate governance enhances meritocratic promotions, and thereby strengthens workers’ incentives to acquire skills. Instead, labor market competition has an ambiguous impact on workers' skill acquisition, as it enhances their wage upon promotion but increases the retention cost of promoted workers. With endogenous skill acquisition, there are multiple equilibria, with social welfare increasing in the share of meritocratic firms. This highlights a new efficiency rationale for improvements in the quality of corporate governance.