Holmstrom (1999) - Managerial Incentive Problems

Reference(s)

Holmstrom B., (1999) "Managerial Incentive Problems: A Dynamic Perspective," Review of Economic Studies, 66(1): 169-182 pdf

Abstract

The paper studies how a person's concern for a future career may influence his or her incen- tives to put in effort or make decisions on the job. In the model, the person's productive abilities are revealed over time through observations of performance. There are no explicit output-contin- gent contracts, but since the wage in each period is based on expected output and expected output depends on assessed ability, an "implicit contract" links today's performance to future wages. An incentive problem arises from the person's ability and desire to influence the learning process, and therefore the wage process, by taking unobserved actions that affect today's performance. The fundamental incongruity in preferences is between the individual's concern for human capital returns and the firm's concern for financial returns. The two need be only weakly related. It is shown that career motives can be beneficial as well as detrimental, depending on how well the two kinds of capital returns are aligned.