The Evolution of Ceo Compensation in Venture Capital Backed Startups

Michael Ewens (Caltech)
Ramana Nanda (Harvard)
Christopher Stanton (Harvard)

Abstract : We use individual-level data to shed light on the evolution of founder-CEO compensation in venture capital-backed startups. We document that having a tangible, marketable product is a fundamental milestone in CEOs' compensation contracts, marking the point at which liquid cash compensation begins to increase significantly -- well before a liquidity event. "Product market fit'' also coincides with key human capital in the startup becoming more replaceable, marking an apparent transition in the firm's lifecycle from "differentiation" to "standardization". Although substantial increases in cash compensation for founder-CEOs in response to milestones improves the certainty equivalent of attempting entrepreneurship relative to flat pay, low cash compensation in the very early years can still deter entrepreneurship for potential entrants. We characterize the types of individuals most likely to be impacted by this constraint and hence those whose ideas are unlikely to be commercialized through VC-backed entrepreneurship.

Optimal Project Design

Daniel Garrett (Toulouse School of Economics)
George Georgiadis (Northwestern Kellogg)
Alex Smolin (Toulouse School of Economics)
Balazs Szentes (London School of Economics)

Abstract : This paper considers a moral hazard model with (i) a risk-neutral agent and (ii) limited liability. Prior to interacting with the principal, the agent can choose the production technology, which is a specification of the agent's cost of generating each output distribution with support in [0,1]. After observing the production technology, the principal offers a wage scheme and then the agent implements a distribution over outputs. First, we show that it is without loss to restrict attention to binary distributions on [0,1], that is, the cost of any other distribution is prohibitively high. Then, we characterize the equilibrium technology defined on the binary distributions and show that the equilibrium payoffs of both the principal and the agent is 1/e. A notable feature of the equilibrium is that the principal is indifferent between offering the equilibrium bonus rewarding output one and anything less than that.

Automation and Top Income Inequality

Omer F. Koru (University of Pennsylvania)

Abstract : For almost 40 years, top income inequality has increased sharply in the US. At the same time, there have been major improvements in automation technology. It is well-known the top income is well approximated by a Pareto distribution. In this paper, we provide a theory that links automation technology to the Pareto tail of the income distribution. We construct a model in which the span of control is defined by the measure of labor used in production. We model this as a convex cost of labor, and it generates a decreasing returns to scale production function. An improvement in automation enables entrepreneurs to substitute labor with capital and it decreases the severity of diseconomies of scale. This leads to higher returns to entrepreneurial skills, to a decrease in the Pareto parameter and to an increase in top income inequality. We rationalize the convex cost of labor using a theory of efficiency wages. Using cross-industry and cross-country data, we provide evidence that there is a significant correlation between automation and the top income inequality.