The success of most firms is built upon hundreds of individuals who take thousands of decisions, making it critical to identify and recruit the best talent. Such human capital is a key source of competitive advantage in a wide range of industries, from service to technology. For instance, the standing of a university depends more on the quality of its professors than on its real estate. Talent is also critical for consultants, salesmen and firms like Netflix, whose human resource manual states “One outstanding employee gets more done and costs less than two adequate employees. We endeavor to have only outstanding employees”.
Differences in talent across firms perpetuate through hiring because talented managers have better judgment and better information. For example, in academia, a star professor can easily evaluate the quality of an applicant’s research. And, at Netflix, talented managers can use their professional connections to investigate a potential recruit.
Based on these tenets – that talent matters and perpetuates through hiring – professors Simon Board, Moritz Meyer-ter-Vehn, and Tomasz Sadzik propose a new model of firm dynamics in their working paper entitled “Recruiting Talent”. The key contribution of the paper is to place talent at center stage, in comparison to traditional models of firm dynamics that characterize firms through their stock of capital or labor. The resulting model generates persistent differences between firms’ talent, productivity and wages, consistent with the large dispersion found in the empirical literature. A firm’s stock of talent thus gives it an advantage in identifying future talent and provides a sustainable competitive advantage.
The first step in the analysis is to show that firms with many talented employees optimally pay high wages and attract the best applicants. Intuitively, skilled recruiters have a comparative advantage in hiring from a high-wage applicant pool with a balance of talented workers, rather than hiring from a low-wage pool in which few talented applicants remain. If firms start off initially similar then, over time, better endowed firms accumulate talent, while the worse endowed hire from poor, deteriorating applicant pools and lose talent. Countering this is the natural regression to mediocrity that results from noise in the hiring process. The economy then converges to a steady state that exhibits persistent heterogeneity in wages, talent and productivity where these two forces offset each other. While low-quality firms could in principle catch up by posting higher wages and hiring more talented workers, it is not profitable for them to do so.
Building on this model, the paper generates a rich set of predictions. An increase in screening skills, say, due to technological innovation, raises the dispersion of wages and the segregation of workers across firms, helping to explain recent trends documented in the empirical literature. The paper also cautions against splurging on “super-stars” for firms that wish to rise in the rankings. The authors show that such a strategy may be a waste of money when the current organization lacks the capabilities to identify the stars of tomorrow; a gradual increase in wages is preferable. Finally, the results show that welfare is increased by policies that reduce wage inequality, lowering the dispersion of talent and the segregation of workers across firms.