Academic journal article Economic Quarterly - Federal Reserve Bank of Richmond

Are We Working Too Hard or Should We Be Working Harder? A Simple Model of Career Concerns

Academic journal article Economic Quarterly - Federal Reserve Bank of Richmond

Are We Working Too Hard or Should We Be Working Harder? A Simple Model of Career Concerns

Article excerpt

In modern corporations, ownership is typically separate from control. Holderness et al. (1999) find that executives and directors, as a group, owned an average of only 21 percent of the stock in corporations they ran in 1995. Typically, employees in lower levels of the hierarchy do not have any ownership. Moreover, employees are motivated by self-interest and not necessarily by the interest of the owners. Therefore, incentive problems arise in most corporations. The financiers cannot assure that employees will not expropriate funds or waste them on unattractive projects. (For a discussion of these corporate governance issues, see Shleifer and Vishny [1997] and Weinberg [2003].) The flows of enormous amounts of capital to firms indicate that, at least in most advanced market economies, the problems of corporate governance have been solved reasonably well. However, problems still arise, as illustrated by the scandals caused by the misreporting of corporate earnings; Shleifer and Vishny (1997) discuss evidence of managerial behavior that does not serve the interest of investors.

In this article, we study how an employee is disciplined by career concerns. Fama (1980) suggests that employees are disciplined by the opportunities provided by the labor market for their services, both within and outside the firm. This is the case when the market does not know the employee's future productivity and learns about it by observing his performance. In general, the employer has to pay more to the employee when the employee is believed to be more productive; otherwise another firm in the market would offer more to him. Thus, the employee's compensation depends on the labor market's belief about his future productivity. Therefore, when the employee decides his actions, he cares about his performance (and, consequently, the performance of the firm) because his performance influences his reputation-i.e., the beliefs about the employee's future productivity.

Consider a salesperson who knows that if the labor market believes that he has high ability (for example, he has a good sales strategy and knowledge of the market), he will more likely be offered a position as a sales manager. The salesperson's sales depends both on his ability and the number of hours worked. Because the market cannot directly observe the hours worked, it does not know if an increase in sales is the result of more hours or greater ability. However, we assume that the market believes that the salesperson works the typical number of hours (we require that the market expectation is confirmed in equilibrium) and interprets the amount sold as a signal of his ability. For example, suppose that the market believes that the salesperson works 40 hours per week. Also, suppose the market observes that the salesperson sells 100 units per week. Then, the market considers the salesperson's ability to be that of someone who sells 100 units in 40 hours. In this situation, the salesperson has incentives to work more hours in order to sell more, to appear more talented, and consequently, to increase the probability of being offered a better job.

A complementary approach to the study of career concerns is one that looks at how to pay employees in order to motivate them to act in the best interest of the employer. Surveys of the literature on optimal contracts can be found in Rosen (1992) and Murphy (1999).l In this case, the salesperson's employer could offer a contract that commits to pay more when the salesperson sells more. Such a contract also would provide incentives to work longer hours. Compensation contracts are not discussed in this article.2

Incentives derived from career concerns are not only important for the top executives of a firm, but also for other employees. Moreover, career-concern incentives matter in many lines of work. For example, an assistant professor writes papers for publication in part because the decision regarding his tenure and future salary depends on the beliefs about his future productivity, which is determined by his past production. …

Search by... Author
Show... All Results Primary Sources Peer-reviewed

Oops!

An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.