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Evidence on Compensation Schemes; Extrinsic Incentives and Intrinsic Motivation

EC951, David Reinstein 2013. Evidence on Compensation Schemes; Extrinsic Incentives and Intrinsic Motivation. Readings.

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Evidence on Compensation Schemes; Extrinsic Incentives and Intrinsic Motivation

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  1. EC951, David Reinstein 2013 Evidence on Compensation Schemes; Extrinsic Incentives and Intrinsic Motivation

  2. Readings • Oriana Bandiera, Rasul and Barankay (2005), “Social Preferences and the Response to Incentives: Evidence from Personnel Data”, Quarterly Journal of Economics, vol. 120 (3); Lazear (2000),  “Performance Pay and Productivity”, The American Economic Review , Vol. 90, No. 5 • See also “7_additional_readings.doc” • Selections from: Charness, Gary, and Peter Kuhn. "Lab labor: What can labor economists learn from the lab?." Handbook of Labor Economics 4 (2011): 229-330. • J. Richard Hackman, Greg Oldham, Robert Janson, and Kenneth Purdy, “A New Strategy for Job Enrichment,”California Management Review, Vol. 17, pp. 57-71. • Aronson, Elliot. "The rationalizing animal." Readings in managerial psychology 4 (1989): 134-144. • Recap: Lazear and Shaw, 2007 • Case studies: Case 1, Nordstrom; Case 2, Lincoln electric.

  3. Does it work? Examples • In October 1988 Du Pont changed it’s payment schedule for nearly all 20,000 employees (including management) • 6 percent of annual pay was placed into a ‘at-risk pool’ • If business exceeded goals, employees would receive a multiple of the money as bonus • If business did not meet goals, employees would lose money • For instance, the fibers division had to achieve target of 4 percent real-earnings growth to recover their at-risk pay

  4. Was this plan a good one? • Poor economy led to high input prices and employees lost money placed in bonus pool • Employees were unhappy • Design problems of plan: • Individual effort only small impact on output • Profits dependent on many random factors outside control employees • No additional information used • Earnings-growth relative to other firms in industry • Market conditions

  5. Lazear(See other set of notes) • Lazear (2000, AER) studied reward schemes of the Safelite Glass Corporation • They changed from hourly wage rates to piece-rates • Results: on average 44 percent higher output per worker, of which • Half due to incentive effects (workers producing more) • Half due to self-selection effects (hiring more productive workers)

  6. Other case studies • Read • Case 1 – Nordstrom • Case 2 – Lincoln Electric

  7. Non-Classical Models/Evidence • “Behavioral” • Prospect theory: Loss aversion, reference-dependent choices -- Fehr and Gotte, 2004; Based on theories of Kahneman and Tversky, 1979 Tries to reconcile Oettinger and Camerer et al. (see below) People suffer discontinuous losses (to “psychological” utility) when outcomes fall below a “reference point,” but may have minimal gains if outcomes are above this reference point. F&G have evidence from a field experiment: Bicycle messengers with varying “piece rates.” Work more shifts but with less effort per shift when rates are higher. Complicated explanation.

  8. Oettinger (1999): • Hot-dog vendors respond to incentives (commission rates); more likely to work on days when wages expected to be higher. • Lavy (2004): Rank-order tournament among teachers in Israel, cash bonuses for the greatest improvements. • Careful econometrics show that the incentive programs improved student scores. Did not seem to show manipulation • But note concerns about perverse incentives; difficulty of using high-powered incentives with multiple tasks; “teaching to the test”

  9. 2. Satisficing/Procedural • Camerer et al. (1999, QJE) • Data from NYC taxi cabdrivers • Find negative and significant wage elasticities (“wages” defined based on prevailing traffic/demand conditions that day) • Drivers “should”intertemporally substitute, working more when wages are higher. But they seem to work less. (Income effects of a day’s wages should be negligible) • Explanation given: make labour decisions “one day at a time,” drivers “set a loose daily income target and quit working when they reach that target (note: could be explained by prospect theory)

  10. 3. Social preferences • Altruism, “collusion” • Benchmarking would seem useful (remember the model with a common shock). But this may lead to collusion. • Oosterbeek (2008): • Field experiment: tournament with 1000/3000/5000 Euro prize had no effect on studying or performance • Various possible explanations Bandeira et al., 2004: • Field experiment (literally) • Productivity is lower under relative incentives then under piece rates • Particularly when working with friends

  11. B. Bandiera et al. study • Data from fruit pickers • Change in compensation scheme from relative compensation to piece rates.

  12. Compensation schemes • Piece rates: • Piece rate β (set each day, based on expected productivity) • K is kilograms fruit picked • Relative compensation: • Rate set according to minimum wage plus constant (w bar) and average productivity (y bar)

  13. With relative compensation, there are externalities: higher effort decreases pay of other workers • This may explain lower productivity • Collusion • Altruism

  14. Results • Productivity increased by at least 50% • Specific evidence/corroboration of theory: If more friends in same field, productivity lower under relative compensation, but not under piece rates • Workers internalize externality only if they can be monitored

  15. 4. Intrinsic motivation • People want to work, to do good, to receive praise, pride in work. • Various evidence for this in lab and field, intuitive Can extrinsic rewards “crowd this out”? • Psychologists, sociologists explanation

  16. A New Strategy for Job Enrichment,”

  17. Desire for Impact • “...the moment when the baby grabs the spoon from the mother’s hand and tries to feed itself. ... We can be sure that the child is not motivated at this point by increased oral gratification. He gets more food by letting mother do it, but by doing it himself he gets more of another kind of satisfaction–a feeling of efficacy.”

  18. (Related to intrinsic motivation) • “Desire for Impact” (Dur and Glazer, 2004) • “Having an impact on the world gives people pleasure as it makes them feel strong and excited” • Various anecdotal evidence for this, some lab evidence, lots of survey evidence, compensating wage differentials • Starting from this assumption, D&G find many interesting results for firm behavior, market structure, principal-agent models, etc.

  19. Related: • Desire for flexibility, desire to “keep doors open” • Shin and Ariely, (2004, Management Science): • Experimental subjects pay money to keep options open far past the point at which doing so maximizes expected outcomes

  20. 5a. Signaling by Worker/Agent • Related to intrinsic motivation. Working hard/well or volunteering may be useful as a signal to others (or to oneself if we want to get psychological) of one’s goodness, altruism, or intrinsic motivation. • If external rewards are provided they may crowd this out. • Various evidence that monetary incentives have negative effects on prosocial behavior (day-care, charitable fundraising.)

  21. (Signaling by Worker/Agent ctd.) • Theory: Benabou and Tirole (2006) • Some evidence: • Ariely et Al. (2007), “Doing Good or Doing Well? Image Motivation and Monetary Incentives in Behaving Prosocially” • Experiment: subjects pressed keys (rode a bicycle) for a favoured/disfavoured cause. They were given financial incentives or not. They were doing this in public or in private.

  22. Results (Ariely et al):

  23. 5b. Signaling by employer/principal • Informed principal models (Maskin and Tirole, 1990, 1992) • Principal knows Agent’s type. High pay may actually be informative of a worker’s low skill (high costs) and be disincentivizing.

  24. 5c. Screening by employer/principal • Low pay (at least at first) may attract: • 1. Those with internal motivation (or a willingness to stay a long time) • -- Nonprofit institutions; high pay could lead to adverse selection • -- University lecturers/professors; the tenure/permanency system • 2. Those who “know” they will succeed • The classic screening story (see treatment in Milgrom and Roberts) • (See Happyness movie)

  25. Further evidence from the lab (and field experiments) • from Notes on Gary Charness and P Kuhn; “Lab labor: what can labor economists learn from the lab?” • Esp. read section III (esp. part 3 and 5)

  26. Lab experiments – useful? • Advantages of the laboratory • -Control: "one of the strengths of lab experiments is the ability to take a specific theoretical model… And have real agents play exactly that game with real monetary consequences” • DR Comment: this is dubious for various reasons • "It is also relatively easy to measure agents' believes in the lab, using monetary incentives.” -Often harder to do in the field • "Unique opportunities… [Learn] the form of strategy used by agents in solving dynamic problems”

  27. Key issue: generalizability lab  real world • Population • Nature of task/environment • Scrutiny and contrast • Stake sizes • Discussion of increased stake sizes… "It is not obvious whether stake's involving larger sums of money or the small stakes that apply to decisions people make on a daily basis are more relevant for economic purposes. It is also the case that large do not necessarily lead to fewer mistakes, as shown in Ariely at all (2008). " • "scrutiny can be present in the field as well, as workers are often monitored ...” • – – I Call This "Blame the Field" • They write: "a comprehensive study by Kammer and Hogarth (1999) indicates that in many cases whether or not a laboratory participant is given financial incentives has little effect on behavior." • However, Charness and Kuhn are claiming that we can measure the impact of the level of incentives, and that we find that greater incentives cause more effort. So this is a bit self-contradictory.

  28. Key design issues • “Stated effort” vs “real effort” • Within or between-subject? Or “strategy method”? • Framing matters • Experimenter as principal? Or subject as principal? • Abstract versus richer context

  29. Multiple periods? • "If the experimenter is interested in one-shot interactions, having only one is period in a sense the cleanest design, but it is also the most expensive approach to gathering experimental data … it can also be problematic [because of learning] • "even though 'standard' game theory predicts no repeated game effects under these conditions, behavior sometimes resembles the predictions of one-shot models more closely in the last few rounds." • DR: – – This may be because of a contrast effect, yielding a false "confirmation" of the theoretical prediction.

  30. Experimental EvidenceSingle-task single agent, incentives(From Charness and Kuhn survey) • Compensated wage cuts reduce effort in animal labor supply studies. I… For both animals and humans, there are large individual subject effects, both in the level of effort supplied for a given level of incentives, and in the responsiveness of effort to incentives. • b) For humans, higher piece rates raise effort (Swenson 1988, Sillamaa 1999a,b, Dickinson 1999). • But: these are basically “within subject”, so contrast effects may be present • Agent self-selection into pay-for-performance schemes reinforces these effects (Lazear 2000; Dohmen and Falk 2006, Cadsby et al. 2007).

  31. c) Not paying at all can yield higher effort than low pay (Gneezy and Rustichini 2000). • d) Effort also responds to the intercept of the worker’s compensation schedule, at least when generosity is seen as intentional (Fehr, Kirchsteiger and Riedl 1993; Charness 2004). • e) Effort decisions can be affected by at least one type of reference point that can be manipulated in the lab: the subject’s expected earnings for the session (Abeler et al, 2009)

  32. (Skip in lecture, read at home) • g) A decision by a principal to use piece rates can also reduce agents’ efforts; a likely explanation is that the introduction of piece rates changes the agents’ interpretation of the implicit contract for labor services (Irlenbusch and Sliwka 2005). • … • j) Sharp discontinuities in reward schedules induce workers to misrepresent their output (Cadsby et al., 2008). • k) Even when there is no strategic independence between workers, workers’ efforts may depend on their co-workers’ efforts (Falk and Ichino 2006). • … “find that average output is higher. Further, the standard deviation of output is lower within worker pairs than between pairs. Essentially, low-productivity workers raise their output towards that of their co-worker when a co-worker is present.” • --Bandeira et al (2009) in the field, find this can go in either direction, and depends on friendship ties

  33. "Dickinson over 1999) pays subjects a piece rate but in some treatments a subject could to choose between two types of leisure: on-versus off-the-job." • "Subject increase their output in the baseline treatment, substituting on-the-job leisure for effort when incentives were strengthened. In the combined treatment, many subjects responded higher wages by working more quickly, but reducing their total work time believing experiment early.” • – Consider issues of working at home, enforced hours, and monitoring. However, the advantage of enforcing on-the-job time may depend on other factors, such as the mobility of workers, and how much the employer may have to pay "upfront" to attract workers under these norms.

  34. (Skip in lecture, read at home) • Cadsby, Song and Tapon (2009) Show That the Effect of Performance Incentives Varies with Agents' Risk Aversion… 25% of Subject – • You Perform Worse When Incentives Are Intensified;… Such Deterioration Increases with Risk Aversion with Measures of Stress.”

  35. “In sum, laboratory tests of the tournament models have identified the following empirical regularities:” • a) A properly-designed tournament can replicate the results of an efficient piece rate in expectation, but generally yields greater variance in mean output across agent groups (Bull, Schotter and Weigelt, 1987). • b) Handicaps, or ‘affirmative action’ tend to improve the performance of tournaments between unequal agents. Part of this effect, however, is due to non-Nash choices by less able agents in the absence of handicaps (sometimes working too hard, sometimes dropping out completely) (Schotter and Weigelt 1992). • c) Under some conditions, decisions to enter into tournaments are surprisingly close to optimal levels (Rapaport 1995). For certain populations, however, entry can be excessive due in part to overconfidence. See Camerer and Lovallo (1989) for MBAs and Niederle and Vesterlund (2007) for men. Allowing risk-averse agents to self-select out of tournaments reduces the between-group variance in output (Eriksson, Teyssier and Villeval 2009).

  36. d) Tournaments can increase risk-taking (Vandegrift and Brown 2003); this effect is not necessarily confined to agents with a low probability of winning (Nieken and Sliwka 2008). • e) Increases in tournament prize spreads can raise sabotage as well as effort; this effect can be strong enough to reduce total output (Harbring and Irlenbusch 2005, Carpenter et al forthcoming). • f) Collusion is rare in anonymous tournaments with more than two contestants (Harbring and Irlenbusch 2008). –But evidence is limited here • g) The effects of interim performance information on agents’ subsequent efforts …. Gill and Prowse (2009) finding that being behind reduces effort (when standard preferences predict no effect) and Berger and Pope (2009) finding the opposite.

  37. Lab evidence, effort in teams (mostly VCM’s not real effort) (Skip in lecture, read at home) • a) In the absence of communication and/or repeated interaction, teams in which agents are paid equal shares of the team’s output perform poorly, with agents’ efforts converging to low, individually rational levels after a few rounds of play (Isaac and Walker 1988; Nalbantian and Schotter 1997). • b) The forcing contracts (essentially group bonuses) suggested by Holmstrom (1982) typically fail to improve outcomes in these environments due to co-ordination problems among agents (Nalbantian and Schotter 1997). • c) Team performance may also be affected by considerations of reciprocity towards the principal, if one exists (Meidinger, Rulliere and Villeval 2003). • d) Adding incentives based on the relative contributions of individual members to the team’s output can improve teams’ performance, if such measures are available (Dickinson and Isaac 1998; Dickinson 2001, Irlenbusch and Ruchala 2008). • e) Adding competition between teams can be more effective than any of the above strategies (Nalbantian and Schotter 1997). Given the tremendous popularity of team sports, both to participants and spectators, it is not at all implausible to us that humans are naturally attracted to such situations and perform well in them.

  38. (Skip in lecture, read at home) • a) The early pooling equilibria at low effort levels predicted by ratchet effects models can be generated in the lab (Cooper, Kagel and Lo 1999). • b) Consistent with Perfect Bayesian equilibrium in the modified game, labor market competition essentially eliminates the ratchet effect (Charness, Kuhn and Villeval 2008), at least in the case where workers’ private information is about their ability (as opposed to the firm’s technology). • c) The early signal-jamming equilibria at high effort levels predicted by career-concerns models can be generated in the lab (Irlenbusch and Sliwka 2006; Koch, Morgenstern and Raub 2009). • d) If agents choose efforts in both periods in a career-concerns game, the effects of making effort publicly observable contradict the career concerns model: Rather than reducing first-period effort (because signal jamming is no longer possible), making effort public actually raises first-period effort (Irlenbusch and Sliwka 2006). This suggests that agents are attempting to signal some personal characteristic that is outside the model, such as ‘honesty’ or a personal willingness to work hard. • e) Even in situations where short-term contracts should theoretically guarantee workers the same return to firm-specific investments as long-term contracts, enforceable long- term contracts induce more worker investments in firm-specific skills (Anderhub, Konigstein and Kubler 2003). • f) The nature of ex post wage bargaining (threat point versus outside offer), and promotion policies (up-or-stay versus up-or-out) affects investments in specific training (Oosterbeek, Sloof and Sonnemans 2007a, b).

  39. Points to Consider on Nummi Case • Why did the efficiency wage not lead to better performance in labor relations in Fremont at the GM plant?Why did GM executives initially feel reluctance to learn from Toyota?What did Toyota have to gain from this collaboration?What is a "weakest link" production process?What was the issue with "grievances" at the GM Fremont plant and how did workers use them to personal benefit?Why did John Shook and the Toyota group of managers agree to hire the first 50 workers from the same troubled pool in Fremont to work at the Nummi plan?Consider the use of teams at the Toyota plants. How would Japanese workers and team leaders respond when production was slow or there was a problem?  Why was "listening to workers suggestions" so revolutionary?What was a problem with the "never stop the line" philosophy at GM plants? Why were workers not given the ability to stop the line?What were the costs of cars going down the line at GM with major problems?What is an "andon cord" and why was it  important?Consider when it is more or less costly to fix problems when they occur or to wait and fix all problems at the end.What are the costs and benefits of "pride"?

  40. Why was it important to have a "radically different relationship" between  workers and management, in terms of trust, for the new system to work?Why might one be skeptical of the initial success of the new NUMMI plants? How does this relate to the "Hawthorne effect"?What are the benefits, from a profit point of view, in the pride that some workers felt in the new Nova/GEO cars?Why did GM fail to rapidly learn the "lessons of Nummi" and adopt these practices more generally?Why do people resist change? Why was there more resistance to change at Van Nuys then at Fremont? Why might seniority and Fairness issues be a barrier to change?"The more efficient  the plant is the fewer workers it needs" – considering the ratchet effect  why can this be a barrier to reforms for efficiency that require worker collaboration?Why does team production require monitoring and "snitching " and sanctions against nonperforming members? Why can this be a barrier to team spirit?Why might losses from change loom larger than gains? What are "entrenched interests" and why might these impede change"?How come "a single plant can't  implement the changes alone"? What is the importance of suppliers of parts for the Toyota/Japanese/kaizen system?

  41. What is meant by the "throw it over the wall" manufacturing? How does this illustrated the difficulties with barriers between divisions?GM was "A collection of individual car companies"...How does the difficulty  in getting managers to consider changes reflect the importance of incentives and rent seeking in distorting decisions?Why does gradual change impede  reform, while dramatic "wake-up calls" can be more effective?Why might companies need to be careful to reward and not discourage "chicken little" predictions?What issues distracted GM from considering Japan driven Reform?Does this illustrate something about core competencies?Why was it somewhat faster to change the production process in factories in Brazil than in the United States?What is the importance of "generational change" in implementing reforms and how does this relate to seniority and entrenched benefits?What was the "Global manufacturing system" implemented with the agreement of GM United Auto Workers union?"Even when they turned the corner on quality, people didn't trust them. "Discuss.

  42. On the floor of the NUMMI plant in Fremont, Earl Ferguson showed me Toyota's solution to all this. It's a thin nylon rope that hangs on hooks along the assembly line, which became a symbol of everything that was different about the Japanese way of making cars-- the andon cord. Earl Ferguson: These cords hanging down, that's the andon cord. It will stop the line. If he pulls the andon cord, then this light's going to come on, right here. Then it'll show up on the screen that this location is down. Frank Langfitt: It also plays a surprisingly cheerful little song. Workers in each area can pick the tune. You hear it all the time in a Toyota plant. The first pull doesn't stop the line, it summons team leaders to the location. They try to correct the problem, and usually, they can do it quickly without stopping production. But if they fail, the line stops. Earl Ferguson: Then they'll correct the problem, then you can pull the andon cord again, and the line will start.

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