Optimal Incentive Contracts in the Presence of Career Concerns: Theory and Evidence
Robert S. Gibbons
Massachusetts Institute of Technology - Sloan School and Department of Economics; National Bureau of Economic Research (NBER)
Kevin J. Murphy
University of Southern California - Marshall School of Business; University of Southern California - Department of Economics; USC Gould School of Law
NBER Working Paper No. w3792
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.
Number of Pages in PDF File: 52
Date posted: June 19, 2004
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