A Continuous-Time Model of Career Concerns and Human Capital Accumulation

We develop a continuous-time model of career concerns that incorporates human capital accumulation throughout the working life. Workers are able to generate an output that follows a diffusion process with a drift that is the sum of effort and ability ("talent"). Talent corresponds to a hidden process that mean-reverts toward a trend that is endogenously changing over time as a consequence of on-the-job skills accumulation. We find that estimates of talent discount past output observations at relatively high rates, leading to broad inefficiencies in the standard setting of career concerns with exogenous talent specifications. Nevertheless, it is precisely this high-discounting which makes human capital accumulation a channel for extracting additional informational rents from belief-distortion. As a consequence, effort levels are typically different to the ones predicted by previous career concerns models, yet inefficiencies are far from being eliminated