1. 1 Compensation & Incentives

2. 2 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

3. 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., b 0 + b 1 [Q +  ] –larger b 1  more pay risk l Extrinsic motivation driven by »PFP = shape of pay function

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

5. 5 Shape: Examples

6. 6 Performance Measurement a. Controllability l A random event occurs... l 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. 7 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 teams l relative evaluation l quantity v. quality l maintenance l short / long term (alienability)

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

9. 9 Weights & Measures l How to set weights across performance measures? »difficulty of task (MD j ) »value of task (MP j ) »error  j ² in measure »set some to zero –implicit/ subjective weight...

10. 10 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

11. 11 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

12. 12 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

13. 13 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