On the efficiency of markets for managers

This paper examines the efficiency of the outside labor market in inducing optimal managerial behavior in the presence of learning. It shows that the incentives provided by the market can be more efficient than the original a nalysis of Holmstrom [6] would suggest. Moreover, under a mild additional a ssumption, the existence of an E-efficient equilibrium can be guaranteed if a manager is patient. This result supports Fama's [4] original idea that t he outside labor market can be efficient in disciplining top managers. Thes e results also suggest that the empirically documented low levels of explic it incentives for managers might be due to the presence of implicit incenti ves provided by the outside market.