Credit Constraints, Competition, and Meritocracy

This paper studies a simple model of the talent-ownership mismatch — or failure of meritocracy — brought about by credit market imperfections that arise as a consequence of agency problems in the borrower-lender relationship. Our model highlights the interaction between the market for firms and the labor market. The key mechanism is that — for given severity of the credit market imperfections — an increase in the wage brings about greater meritocracy. Specifically, a higher wage increases the incentive of untalented firm owners to relinquish the control of their firms, because it improves the payoff they get as workers and reduces — by increasing labor costs — the profit they earn as entrepreneurs.