Profit Sharing and the Role of Professional Partnerships

Abstract

When it is hard to assess service quality, firms will suboptimally hire low ability workers. We show that organizing as a profit-sharing partnership can alleviate these problems. Our theory explains the relative scarcity of partnerships outside of professional service industries such as law, accounting, medicine, investment banking, architecture, advertising, and consulting. It also sheds light on features of partnerships such as up-or-out promotion systems, the use of noncompete clauses, and recent trends in professional service industries.