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

This paper studies optimal incentive contracts when workers have career concerns--concerns about the effects of current performance on future compensation. We show that 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 for workers close to retirement because career concerns are weakest for these workers. We find empirical support for this prediction in the relation between chief executive compensation and stock market performance.

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