European Business Schools Librarian's Group

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No 999: Firm-Specific Human Capital, Organizational Incentives, and Agency Costs: Evidence from Retail Banking

Douglas H. Frank Jr. () and Tomasz Obloj ()

Abstract: This paper explores conflicting implications of firm-specific human capital (FSHC) for firm performance. Existing theory predicts a productivity effect that can be enhanced with strong incentives. We propose an offsetting agency effect: FSHC may facilitate more sophisticated “gaming” of incentives, to the detriment of firm performance. Using a unique dataset from a multiunit retail bank, we document both effects and estimate their net impact. Managers with superior FSHC are more productive in selling loans but are also more likely to manipulate loan terms to increase incentive payouts. We find that resulting profits are two percentage points lower for high-FSHC managers. Finally, profit losses increase more rapidly for high-FSHC managers, indicating adverse learning. Our results suggest that FSHC can create agency costs that outweigh its productive benefits.

Keywords: FSHC; firm-specific human capital; firm performance; incentives; multiunit retail bank

JEL-codes: G00

41 pages, May 16, 2013

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