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

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  • 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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Bibliographic Info

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: Jul 1991
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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. MacDonald, Glenn M, 1982. "A Market Equilibrium Theory of Job Assignment and Sequential Accumulation of Information," American Economic Review, American Economic Association, American Economic Association, vol. 72(5), pages 1038-55, December.
  2. Sherwin Rosen, 1985. "Prizes and Incentives in Elimination Tournaments," NBER Working Papers 1668, National Bureau of Economic Research, Inc.
  3. Michael Waldman, 1984. "Job Assignments, Signalling, and Efficiency," RAND Journal of Economics, The RAND Corporation, vol. 15(2), pages 255-267, Summer.
  4. Laffont, Jean-Jacques & Tirole, Jean, 1988. "The Dynamics of Incentive Contracts," Econometrica, Econometric Society, Econometric Society, vol. 56(5), pages 1153-75, September.
  5. Bentley MacLeod & James M. Malcomson, 1985. "Reputation and Hierarchy in Dynamic Models of Employment," Working Papers, Queen's University, Department of Economics 628, Queen's University, Department of Economics.
  6. Lazear, Edward P, 1986. "Salaries and Piece Rates," The Journal of Business, University of Chicago Press, University of Chicago Press, vol. 59(3), pages 405-31, July.
  7. Coughlan, Anne T. & Schmidt, Ronald M., 1985. "Executive compensation, management turnover, and firm performance : An empirical investigation," Journal of Accounting and Economics, Elsevier, Elsevier, vol. 7(1-3), pages 43-66, April.
  8. Aron, Debra J, 1987. "Worker Reputation and Productivity Incentives," Journal of Labor Economics, University of Chicago Press, University of Chicago Press, vol. 5(4), pages S87-106, October.
  9. Richard A. Lambert, 1983. "Long-Term Contracts and Moral Hazard," Bell Journal of Economics, The RAND Corporation, The RAND Corporation, vol. 14(2), pages 441-452, Autumn.
  10. Baron, David P & Besanko, David, 1987. "Commitment and Fairness in a Dynamic Regulatory Relationship," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 54(3), pages 413-36, July.
  11. Smith, Clifford Jr. & Warner, Jerold B., 1979. "On financial contracting : An analysis of bond covenants," Journal of Financial Economics, Elsevier, Elsevier, vol. 7(2), pages 117-161, June.
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