Career Concerns and Performance Reporting in Optimal Incentive Contracts

In many contracting settings incentives are provided not only through transfers but also through performance reports to prospective employers. This paper studies a principal-agent model of this kind, in which the principal sends a non-verifiable report of output to a competitive labor market interested in the agent's ability. It is assumed that the principal and agent write an enforceable contract over both payments and reports as a function of output, and that the contract terms they agree to cannot be observed by the market. When contracts are unrestricted, reports cannot affect the agent's future wage in equilibrium, because the agent will always pay the principal to give a good report. Under limited liability, reports can affect future wages, but only by designating output as "good" or "bad." This informative performance reporting benefits the principal, and may more than make up for the costs imposed by limited liability. The possibilities that the market may have some direct information about output, that the principal may have additional information about the agent's ability, and that the principal may have psychological or reputational costs of misreporting output are also considered.