When it is hard to assess product quality, firms will sub-optimally hire low ability workers. We show that organizing as a profit-sharing partnership can alleviate these problems.
Our theory explains the historical prevalence of profit sharing in professional service industries such as law, accounting, medicine, investment banking, architecture, advertising, and consulting, and the relative scarcity of profit sharing in other industries.
It also sheds light on features of partnerships such as up-or-out promotion systems, and on recent trends in professional service industries.( JEL codes: D20, D82, J33, J44, J54, L22.