Optimal tolerance for failure

• We examine the effect of a manager's success on the decision to renew his contract.
• The model features uncertainty with respect to ability as well as moral hazard.
• Success increases an agent's wealth, which makes it harder to motivate a manager.
• It is optimal to retain successful managers if effort is important or hardly matters.
• Our model may explain the low empirical correlation between success and CEO tenure.

We consider the problem of an employer who has to choose whether to reemploy agents with a positive track record or agents who were unsuccessful. While previously successful managers are likely to be of high ability, they have also accumulated wealth and will be harder to motivate in the future. It may hence be optimal to retain unsuccessful managers but not successful ones. The result that the optimal tenure of a manager may not be increasing in his success is consistent with empirical studies that find a low correlation between firm success and managerial turnover.