Firm Lifecycles: Linking Employee Incentives and Firm Growth Dynamics

We develop a formal model that links the design of a firm’s incentive structure to the firm’s rate of growth. Motivated by the prospect of promotion, employees exert effort over and above their formal job requirements to improve processes and make the firm more efficient. Firms that are growing faster, in turn, have more promotion opportunities which links firms’ growth rate and the incentives managers experience. We show that the associated dynamics lead to three distinct epochs of a firm’s lifecycle: rapid growth and high-powered incentives driven by frequent promotion opportunities; moderate growth with infrequent promotion opportunities but large salary increases contingent on promotion; and finally stagnant firms with low-powered incentives.

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