Chapter 10: Pay for Performance

Question 1

What are the benefits of stronger incentive intensities?

Answer 1

1) Employees are motivated to work harder
2) Stronger incentives attract more productive employees who have higher market values
3) Employees have to be paid a higher risk premium

Question 2

What is the ratchet effect?

Answer 2

refers to a situation where workers subject to performance pay choose to restrict their output because they rationally anticipate that firms will respond to higher output levels by raising output requirements or by cutting pay

Question 3

What is the principal-agent problem?

Answer 3

a problem that arises when an agent(employee) acts on behalf of a principal (firm’s owner), but has different objectives

Question 4

What are the factors affecting the strength of incentives?

Answer 4

1) accuracy of performance evaluation
2) value of employee effort
3) risk aversion
4) subjective evaluation and trust
5) sorting

Question 5

What are the four types of reward structures?

Answer 5

1) Reward
2) Punishment
3) Lump-sum bonus, demotion, or promotion
4) Bonus w/ floor & cap

Question 6

Pros and cons of reward structure?

Answer 6

pro: incentivizes employees to perform better

con: could be distorted or manipulated

Question 7

Pros and cons of punishment structure?

Answer 7

pro: reduces distortion and manipulation

con: could be hard to motivate

Question 8

Pros and cons of lump-sum bonus, demotion, or promotion?

Answer 8

pro: incentivizes employees to perform better

con: it only motivates employees who are very close to the deadline, and it doesn’t motivate all employees

Question 9

Pros and cons of bonus w/ floor & cap

Answer 9

pro: reduces distortion, sabotage, and manipulation

con: motivated to do better up until a certain point