(2017) by the Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association In this article, we study market-induced, external incentives similar to career concerns jointly with standard, contractual incentives linking compensation to performance. We consider a dynamic principalagent problem in which the agent's outside option is determined endogenously in a competitive labor market. In equilibrium, strong performance increases the agent's market value. When this value becomes sufficiently high, the threat of the agent quitting forces the principal to increase the agent's compensation. The prospect of obtaining this raise gives the agent an incentive to exert effort, which reduces the need for standard incentives. In fact, whenever the agent's option to quit is sufficiently close to being in the money, the market-induced incentive eliminates the need for standard incentives altogether: Compensation becomes completely insensitive to current performance.
