Agency contracts for risky projects in the presence of labor market mobility when output realizations are lagged

Moral hazard problems are likely to arise when firms hire agents to select risky projects in which the output is lagged even for one period. Precluding the possibility for involuntary servitude, if an external labor market exists such that agents are free to move to an outside firm, they may be tempted to increase their own income streams at the expense of the firm's. By following a strategy of shirking, agents will save the costs of effort. And by consistently exiting firms for an outside employer they will escape any accountability for the poor output likely to result from their lack of effort. To eliminate the moral hazard problem, incumbent and external firms alike will design wage contracts such that the costs of voluntary separation from the firm will preclude any possibility of improving one's income stream by following a "shirk-then-leave" strategy. This will be achieved by specifying contracts in which some percentage of the agent's compensation is made output-contingent and therefore, time-dependent. Such contracts will induce agents to stay with the firm at least until the output outcome has been realized. In addition, it is assumed that there is a spectrum of risky projects in terms of the amount of capital placed at risk. Then, in order to offset the higher amount of risk firms will assign the more reputable agents to the riskier projects. And since assignments over riskier projects imply higher levels of compensation, agents will be financially motivated to earn favorable reputations and therefore, higher assignments. One preliminary result is that all firms--incumbent and external--will follow the same compensation policy whether output is publicly-observable or not. I also find that the existence of mobility within an external labor market is weakly welfare-improving for the incumbent firm. Another result is that agents should be more motivated by reputational (i.e., career) concerns in the early stages of their careers, and more motivated by monetary concerns later in their careers.