Daniel Ferreria is a Professor of Finance at the London School of Economics and Political Science, and Radoslawa Nikolowa is an Associate Professor of Economics and Finance at Queen Mary University of London. This post is based on their article published in The Journal of Finance. Related research from the Program on Corporate Governance includes The Growth of Executive Pay by Lucian A. Bebchuk and Yaniv Grinstein; The CEO Pay Slice (discussed on the Forum here) by Lucian A. Bebchuk, Martijn Cremers, and Urs Peyer; and Paying for Long-Term Performance (discussed on the Forum here) by Lucian A. Bebchuk and Jesse M. Fried.
CEOs, corporate executives, managing directors in investment banking, and partners in law firms are all positions that are considered prestigious. They are also highly paid. This bundling of prestige and pay is a common feature in many high-level jobs. Specifically, in professional services firms, being promoted to managing director or partner usually results in an increase in both pay and prestige.
There are good reasons why prestigious jobs pay more. After all, we expect those promoted to top positions to be highly talented, and top talent is scarce. Still, since most people enjoy being promoted to a prestigious position, why do firms need to pay so much more to those at the top of hierarchies?
In Economics, the traditional framework for thinking about jobs with desirable (or undesirable) characteristics is the theory of compensating differentials. In The Wealth of Nations (Book X, Part I, 1776), Adam Smith writes: “Honour makes a great part of the reward of all honourable professions. In point of pecuniary gain, all things considered, they are generally under-recompensed.” According to this logic, employees should be willing to “pay” for desirable job characteristics by accepting lower financial compensation. Thus, all else constant, prestigious jobs should pay less. In the article “Prestige, Promotion, and Pay,” published in The Journal of Finance, we argue that when firms design internal careers to attract potential employees, prestigious jobs should pay more.
