Product Market Competition, Managerial Talent, and Innovation

Abstract: We examine the relationship between product market competition and innovation in an agency model where risk-neutral, wealth-constrained, effort exerting managers a) are heterogeneous in talent, and b) can choose the industry in which to work. We show that when managerial talent information is known to employers but effort is not contractible, innovation increases with competition, as more talented managers self-select into more competitive industries, where their ability to extract rents is highest. In contrast, when talent information is not available to employers, talented managers may try and signal their type by selecting moderately competitive industries to avoid "imitation" by less talented managers.