Managerial Talent Misallocation and the Cost of Moral

This paper identifies the sources and the magnitude of inefficiency in the allocation of CEOs to firms in the market for talent. I develop an estimable model which illustrates that the presence of moral hazard not only leads to inefficiency caused by risk sharing across the two parties, but also creates inefficiency due to a talent misallocation. The talent misallocation is novel to the literature. A new empirical method is proposed to identify the separate surplus of both firms and CEOs in a matching market with moral hazard. An application of this method to the U.S market for CEOs shows that the aggregate efficiency loss due to talent misallocation is $12.64 billion. This is more than four times as large as the loss stemming from risk-sharing between firms and CEOs. The findings suggest that studies focusing solely on risk-sharing can severely underestimate efficiency losses due to moral hazard