Aligning Ambition and Incentives

Abstract

In many economic situations, several principals contract with the same agents sequentially. From observing agents' performance the first principal obtains information regarding their abilities that is not directly available to outsiders. This has profound implications for the design of incentive contracts. We show that the principal always strategically distorts information revelation to future principals about the performance of her agents. The second main result is that she can limit her search for optimal incentive schemes to the class of relative performance contracts that cannot be replicated by contracts based on individual performance only. This provides a new rationale for the optimality of such compensation schemes.