Compensation Incentives 1 Brief Overview of Compensation l

Compensation & Incentives 1

Brief Overview of Compensation l Directly related to all org. policy goals » investment » matching » motivation l 3 basic elements » level » composition ($ v. benefits) » pay for performance 2

Incentives: The Simple Model l Perf. measure = Q(e) + e » measuring effect of effort » depends on e – tradeoff measurement cost v. error l Pay = I[Q(e) + e] » e. g. , b 0 + b 1[Q + e] – larger b 1 Þ more pay risk l Extrinsic motivation driven by » PFP = shape of pay function 3

Shape of Pay. Performance Relation l b 0 = level of pay » no incentive intensity except firing threat determines risk · b 1 = slope » » also 4

Shape: Examples 5

Performance Measurement a. Controllability l A random event occurs. . . l Hold the employee accountable? » e. g. , Q + e = (a + a)·e + e – a known by worker ex ante – known by firm ex post » if employee affects response to event, yes » if relevant decision rights are given to another employee, no » need for ex post subjectivity in evaluating performance 6

Performance Measurement b. Distortions l Lensing metaphor » broader measures include more. . . – effects of actions (controllables) – uncontrollables » key perf. measurement tradeoff – narrower measures reduce risk but induce distortions – most perf. meas. issues are about distortions l l l teams relative evaluation quantity v. quality maintenance short / long term (alienability) 7

Incentives: The Multitask Model l For each task j. . . » Qj = perf. measure » PFPj = shape of pay – relative weights PFPj balance incentives across tasks l l relative price system coordination mechanism 8

Weights & Measures l How to set weights across performance measures? » difficulty of task (MDj) » value of task (MPj) » error sj² in measure » set some to zero – implicit/ subjective weight. . . 9

Defining Jobs by Measurement Characteristics l Bundling tasks into measures » automatic weights / coordination across tasks – complementary tasks » Task Identity l Bundling measures into jobs » similar measurement error 10

Incentives: Fit w/ other Org. Policies l Careers » incentives for skill acq. , firm specific human capital » promotions may be incentives l Job / org. design » allocation of decision rights l Voice » info. for decision making » feedback perf. measures » implicit contracting when there is subjectivity 11

Subjectivity & Incentives l Subjective. . . » . . . measures » . . . weights on objective measures » why? – ‘lensing’ adjustment of uncontrollables – dynamically adapt weights – abstract, complex, knowledge work – necessary in nearly all jobs » problem of trust – implicit contracting – supervisor incentives – process issues 12

Some Summary Points l You get what you pay for » incentives work; that’s the problem! – Texas chain saw of motivation – does not imply that extrinsic motivation should be ignored l To mitigate distortions, use. . . » overlapping incentives » controls l Incentives v. intrinsic motivation » creativity 13