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Optimal Incentive Contracts In The Presence Of Career Concerns: Theory And Evidence

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  • GIBBONS, R.
  • MURPHY, K.J.

Abstract

This paper studies career concerns -- concerns about the effects of current performance on future compensation -- and describes how optimal incentive contracts are affected when career concerns are taken into account. Career concerns arise frequently: they occur whenever the market uses a worker's current output to update its belief about the worker's ability and competition then forces future wages (or wage contracts) to reflect these updated beliefs. Career concerns are stronger when a worker is further from retirement, because a longer prospective career increases the return to changing the market's belief. In the presence of career concerns, the optimal compensation contract optimizes total incentives -- the combination of the implicit incentives from career concerns and the explicit incentives from the compensation contract. Thus, the explicit incentives from the optimal compensation contract should be strongest when a worker is close to retirement. We find empirical support for this prediction in the relation between chief-executive compensation and stock-market performance.

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Bibliographic Info

Paper provided by Massachusetts Institute of Technology (MIT), Department of Economics in its series Working papers with number 563.

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Length: 48 pages
Date of creation: 1990
Date of revision:
Handle: RePEc:mit:worpap:563

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Postal: MASSACHUSETTS INSTITUTE OF TECHNOLOGY (MIT), DEPARTMENT OF ECONOMICS, 50 MEMORIAL DRIVE CAMBRIDGE MASSACHUSETTS 02142 USA
Phone: (617) 253-3361
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Web page: http://econ-www.mit.edu/
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Postal: MASSACHUSETTS INSTITUTE OF TECHNOLOGY (MIT), DEPARTMENT OF ECONOMICS, 50 MEMORIAL DRIVE CAMBRIDGE MASSACHUSETTS 02142 USA
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Keywords: financial incentives ; occupations ; retirement ; market ; contracts;

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References

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  1. Michael Waldman, 1984. "Job Assignments, Signalling, and Efficiency," RAND Journal of Economics, The RAND Corporation, vol. 15(2), pages 255-267, Summer.
  2. Lazear, Edward P, 1986. "Salaries and Piece Rates," The Journal of Business, University of Chicago Press, vol. 59(3), pages 405-31, July.
  3. Aron, Debra J, 1987. "Worker Reputation and Productivity Incentives," Journal of Labor Economics, University of Chicago Press, vol. 5(4), pages S87-106, October.
  4. Smith, Clifford Jr. & Warner, Jerold B., 1979. "On financial contracting : An analysis of bond covenants," Journal of Financial Economics, Elsevier, vol. 7(2), pages 117-161, June.
  5. Laffont, Jean-Jacques & Tirole, Jean, 1988. "The Dynamics of Incentive Contracts," Econometrica, Econometric Society, vol. 56(5), pages 1153-75, September.
  6. Sherwin Rosen, 1985. "Prizes and Incentives in Elimination Tournaments," NBER Working Papers 1668, National Bureau of Economic Research, Inc.
  7. Richard A. Lambert, 1983. "Long-Term Contracts and Moral Hazard," Bell Journal of Economics, The RAND Corporation, vol. 14(2), pages 441-452, Autumn.
  8. Baron, David P & Besanko, David, 1987. "Commitment and Fairness in a Dynamic Regulatory Relationship," Review of Economic Studies, Wiley Blackwell, vol. 54(3), pages 413-36, July.
  9. MacDonald, Glenn M, 1982. "A Market Equilibrium Theory of Job Assignment and Sequential Accumulation of Information," American Economic Review, American Economic Association, vol. 72(5), pages 1038-55, December.
  10. Bentley MacLeod & James M. Malcomson, 1985. "Reputation and Hierarchy in Dynamic Models of Employment," Working Papers 628, Queen's University, Department of Economics.
  11. Coughlan, Anne T. & Schmidt, Ronald M., 1985. "Executive compensation, management turnover, and firm performance : An empirical investigation," Journal of Accounting and Economics, Elsevier, vol. 7(1-3), pages 43-66, April.
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