Getting Paid: Reward Systems

Question 1

Coordination problem

Answer 1

Get everyone to work together to jointly pursue goals of the organization

Question 2

Agency problem

Answer 2

Not a simple optimization problem because what motivates people varies on multiple dimension

Question 3

Linking pay to perfomance

Answer 3

Y=E+n
W=s+bY

y=sales, profits, performance evaluations
E= effort by workers
n=”noise”

W= workers’ pay
s=fixed component
b=sensitivity of pay to performance
(s,b can range from 0 to huge)

Question 4

Merit pay

Answer 4

• base salary tied to position

- increases based on specific periodic performance appraisals

Question 5

Profit Sharing

Answer 5

• based on corporate performance

- may be linked to specific (group) contributions (stock options)

Question 6

Incentive pay

Answer 6

• For a specific performances

- For learnings skills

Question 7

What can go wrong with PFP?

Answer 7

• Pay not seen as contingent on individual performance: unclear goals, free rider problem
• Performance ratings seen as biased or uninformative: subjective evaluations leave process open to bias/politics, “egocentric bias”, managers dislike making performance distinctions among their subordinates
• You think you pay for A but in reality encouraging B

Question 8

When to use group incentives?

Answer 8

• work is highly interdependent (teamwork matters)
• group can encourage coordination and knowledge transfer
• peer norms or culture can overcome the “free rider effect”

Question 9

When are individual incentives sensible?

Answer 9

• Output is sensitive to worker’s effort
• Interdependencies among workers not large
• Level of risk beyond worker’s control not large
• Output easy to measure
• No tensions between multiple dimensions of output

Question 10

intrinsic Motivation

Answer 10

behavior driven by internal rewards

Question 11

Extrinsic Motivation

Answer 11

behavior driven by external rewards