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Optimal Incentive Contracts in the Presence of Career Concerns: Theory and Evidence

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Author Info
Robert Gibbons
Kevin J. Murphy
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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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3792.

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Date of creation: Sep 1992
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Publication status: published as Journal of Political Economy, Vol. 100, No. 3, pp. 468-505, (June 1992).
Handle: RePEc:nbr:nberwo:3792

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  1. Baron, David P & Besanko, David, 1987. "Commitment and Fairness in a Dynamic Regulatory Relationship," Review of Economic Studies, Blackwell Publishing, vol. 54(3), pages 413-36, July. [Downloadable!] (restricted)
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  3. MacLeod, W Bentley & Malcomson, James M, 1988. "Reputation and Hierarchy in Dynamic Models of Employment," Journal of Political Economy, University of Chicago Press, vol. 96(4), pages 832-54, August. [Downloadable!] (restricted)
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  4. Richard A. Lambert, 1983. "Long-Term Contracts and Moral Hazard," Bell Journal of Economics, The RAND Corporation, vol. 14(2), pages 441-452, Autumn. [Downloadable!] (restricted)
  5. Laffont, Jean-Jacques & Tirole, Jean, 1988. "The Dynamics of Incentive Contracts," Econometrica, Econometric Society, vol. 56(5), pages 1153-75, September. [Downloadable!] (restricted)
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  6. 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. [Downloadable!] (restricted)
  7. Aron, Debra J, 1987. "Worker Reputation and Productivity Incentives," Journal of Labor Economics, University of Chicago Press, vol. 5(4), pages S87-106, October. [Downloadable!] (restricted)
  8. 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. [Downloadable!] (restricted)
  9. Lazear, Edward P, 1986. "Salaries and Piece Rates," Journal of Business, University of Chicago Press, vol. 59(3), pages 405-31, July. [Downloadable!] (restricted)
  10. 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. [Downloadable!] (restricted)
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