The Effect of Career Concerns on the Contracting Use of Public and Private Performance Measures

Abstract

We model career concerns in a regime where a linear incentive contract includes a mix of a publicly observed performance measure and a second, correlated, private measure that is not observed by the labor market. Under this "mix" regime, we find that agent effort and total agency payoff levels are higher, and the weight on the public measure is lower, than in regimes with either public-only or private-only performance measures. Intuitively, public measures create career concerns and reduce both the need for explicit incentives and the risk premium the principal must pay to the agent. Private measures enable the principal to reward the agent more efficiently for the higher levels of effort that arise despite lower explicit incentives. The results suggest implicit incentives arising from career concerns may help explain recent empirical evidence of firms using a combination of private and public performance measures as a basis for rewarding executives.

Keywords: career concerns, incentives, performance measures

JEL Classification: J33, J41, D82, M40, M46