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16 Cards in this Set
- Front
- Back
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Optimal incentive intensity (formula): |
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Optimal fixed wage component (formula): |
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5 Problems with incentive contracts |
1. Performance measures depend on factors that cannot be controlled by employee (Trade-off between incentives and compensation for risk) 2. Ultimate performance depends on different tasks(Multi-tasking problem, alignment problem) 3. Similar asymmetric information problem with regard to performance measures thaneffort(“Gaming the rules”, manipulation and cheating) 4. Monitoring necessary to measure performance(Crowding out, hidden costs of control) 5. Performance often depends on team effort(Free rider problem) |
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Performance measures depend on factors that cannot be controlled by employee – Random factors such as weather, business cycle, etc. – Performance pay increases uncertainty of wage |
Trade-off between incentives and compensation for risk |
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Ultimate performance depends on different tasks – Not all tasks are easily measurable – Distortions in effort allocation if performance pay depends mainly on performance of measurabletasks |
Multi-tasking problem, alignment problem |
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Similar asymmetric information problem with regard to performance measures thaneffort – Agents can affect performance measures trough other means than effort provision |
“Gaming the rules”, manipulation and cheating |
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Monitoring necessary to measure performance – Can be regarded as controlling by employee and crowd out intrinsic motivation |
Crowding out, hidden costs of control |
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Performance often depends on team effort – Difficult to measure individual contribution |
Free rider problem |
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Extrinsic motivation |
Motivation spurred by external rewards, i.e. job is ameans to an end – Money (or goods and services that can be bought) – Career concerns / higher future income – Status – Praise |
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Intrinsic motivation |
Motivation resulting from the work itself, i.e. jobdirectly satisfies a need – Job satisfaction – Experience of competence and autonomy/self-determination – Experience of relatedness to others – Compliance of standards for their own sake – Etc. |
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However, additional costs of monitoring if it negatively affectsintrinsic motivation -> “hidden costs of control” - describe |
- Principal monitors performance of agent in order to prevent opportunisticbehavior of agent – If principal trust agent not to behave opportunistically, no monitoringnecessary – Hence, monitoring signals distrust: If the principal monitors agent moreclosely she shows that she believes agent to behave opportunistically – If the agent perceives monitoring as controlling and signaling distrust,intrinsic work motivation might be reduced (“crowding-out of intrinsicmotivation”) -> lower effort provision |
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1. Incentives might reduce perceived autonomy and self-determinationleading to lower intrinsic motivation (no answer) (see other side) |
2. With incentives, work relationship can be transformed from aperceived relational contract to a transactional contract (no answer) (see other side) |
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Crowding-out effect can dominate price effect if: (3 things) |
1. – intrinsic motivation is high 2. – incentive effect is small 3. – intervention is considered controlling and reducing work autonomy -> "Pay enough or don't pay at all" |
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Summary card: 1. Firms can motivate employees with extrinsic incentives orrely on intrinsic motivation 2. Incentive contracts can have hidden costs and crowd-outintrinsic motivation – Control associated with incentives can signal distrust – Incentives can reduce perceived work autonomy – Incentives can change the work relationship from a relational to atransactional contract |
3. Incentives might still be necessary – Motivate workers with low intrinsic motivation – Direct effort towards those tasks relevant for firm 4. Good incentive systems might crowd-in intrinsic motivation |
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Optimal wage should equal market wage plus compensation for the highereffort costs plus a wage premium (formula): |
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