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.

Our estimates of the pay-performance relation (including pay, options, stockholdings, and dismissal) for chief executive officers indicate that CEO wealth changes $3.25 for every $1,000 change in shareholder wealth. Although the incentives generated by stock ownership are large relative to pay and dismissal incentives, most CEOs hold trivial fractions of their firm's stock, and ownership levels have declined over the past 50 years. We hypothesize that public and private political forces impose constraints that reduce the pay-performance sensitivity. Declines in both the pay-performance relation and the level of CEO pay since the 1930s are consistent with this hypothesis.

This paper studies optimal incentive contracts when workers have career concerns--concerns about the effects of current performance on future compensation. The authors 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. The authors find empirical support for this prediction in the relation between chief-executive compensation and stock-market performance.

The authors' estimates of the pay-performance relation (including pay, options, stockholding, and dismissal) for chief executive officers indicate that CEO wealth changes $3.25 for every $1,000 changes in shareholder wealth. Although the incentives generated by stock ownership are large relative to pay and dismissal incentives, most CEOs hold trivial fractions of the firms' stock, and ownership levels have declined over the past fifty years. The authors hypothesize that public and private political forces impose constraints that reduce the pay-performance sensitivity. Declines in both the pay-performance relation and the level of CEO pay since the 1930s are consistent with this hypothesis.