EMO theory Flashcards
What is comparative performance evaluation?
Comparative performance evaluation is a method of payment where a worker’s payment is based on his performance relative to the performance of other workers.
How might comparative performance evaluation solve the two problems associated with individual incentive contracts?
Comparative performance evaluation may solve both problems simultaneously. If workers are paid based on relative performance rather than on absolute performance, the contract is less risky because the random shock has less impact on the relative output than the absolute one. This method can mitigate the cost of paying each team member as the residual claimant of his contribution and compensate for the risks associated with unobservable random factors outside the control of a team member.
What are the practical drawbacks of individual incentive contracts, even if an individual’s contribution to the team’s output is perfectly measurable?
Individual incentive contracts can have two problems.
First, the ideal contract requires that each team member gets paid based on their contribution to the team’s output, which can be expensive for the company.
Second, if a team member is risk-averse, they may only agree to a contract that pays them a high reward for their work if they are also offered a high base wage to make up for any risks they may face
: What are the advantages of comparative performance evaluation over contracts based on absolute performance?
The advantages of comparative performance evaluation over contracts based on absolute performance are that it can be less risky, as the contract is less affected by random shocks, and it incentivizes team members to expend the first-best level of effort.
What are the practical disadvantages of comparative performance evaluation?
The practical disadvantages of comparative performance evaluation are that it may provide team members with little incentive to help each other, and team members may be inclined to sabotage other team members to improve their own relative performance. Additionally, team members have an incentive to conspire against the principal not to work hard because such conspiracy need not have an impact on their relative performance.
Accepting what kind of contract may be inattractive for a risk adverse agent?
A contract that is dependent on external factors that our outside the agent’s control such as weather (however for a risk-neutral agent this won’t be an issue)
Performance based on team performance is ineffective because
it can bring about the free-rider problem where team members benefit from the work of other members
How can the free-rider problem be solved in team performances?
- Increasing the bonus per unit of team output substantially
- implementing comparative performance evaluation
- repeated interaction (punishment in case of low effort)
What are the two practical drawbacks behind individual incentive contract?
- compensation packages like such soon become very expensive for the company
- an issue arises when output is determined by external factorsq
Under a tournament (comparative performance evaluation) the larger the team…
the greater the price value
According to the comparative performance method, the larger the prize v the team members can win, the more the :
team members work
