Corporate Governance, Favoritism and Careers

Careers are often shaped by favoritism, even though this undermines the performance of firms. When controlling shareholders weigh the efficiency costs of favoritism against its private benefits, the quality of corporate governance enhances meritocratic promotions and so encourages workers’ skill acquisition. The impact of labor market competition, however, is ambiguous: by raising wages upon promotion, it fosters the supply of skilled labor but lowers the demand for it. With endogenous skill acquisition, there are multiple equilibria, and social welfare increases with the share of meritocratic firms. This brings out a new efficiency rationale for enhancing the quality of corporate governance