1

Compensation & Incentives

2

Brief Overviewof Compensation

Directly related to all org. policy goals» investment

» matching

» motivation

3 basic elements» level

» composition ($ v. benefits)

» pay for performance

3

Incentives:The Simple Model

Perf. measure = Q(e) + » measuring effect of effort

» depends on – tradeoff measurement cost v. error

Pay = I[Q(e) + ]» e.g., b0 + b1[Q + ]

– larger b1 more pay risk

Extrinsic motivation driven by

» PFP = shape of pay function

4

Shape of Pay-Performance

Relation

b0 = level of pay b1 = slope» no incentive » incentive intensity

except firing threat » also determines risk

Tradeoff incentives v. risk

5

Shape: Examples

6

Performance Measurement

a. Controllability

A random

event

occurs ...

Hold the employee accountable?» e.g., Q + = (a + )·e +

– 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

7

Performance Measurement

b. Distortions

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 teams relative evaluation quantity v. quality maintenance short / long term (alienability)

8

Incentives:The Multitask Model

For each task j ...» Qj = perf. measure

» PFPj = shape of pay– relative weights PFPj balance incentives

across tasks relative price system coordination mechanism

9

Weights & Measures

How to set weights across performance measures?

» difficulty of task (MDj)

» value of task (MPj)

» error j² in measure

» set some to zero– implicit/ subjective weight ...

10

Defining Jobsby Measurement Characteristics

Bundling tasks into measures» automatic weights /

coordination across tasks– complementary tasks

» Task Identity

Bundling measures into jobs» similar measurement error

11

Incentives: Fit w/ other Org. Policies

Careers» incentives for skill acq., firm

specific human capital

» promotions may be incentives

Job / org. design» allocation of decision rights

Voice» info. for decision making

» feedback perf. measures

» implicit contracting when there

is subjectivity

12

Subjectivity & Incentives

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

13

SomeSummary Points

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

To mitigate distortions, use ...» overlapping incentives

» controls

Incentives v. intrinsic motivation» creativity