Lektion 12 - Monetary incentive systems and motivation Flashcards
(!) Describe the different roles of compensation
Pay:
- Ensure reasonable pay by laws & union agreement
- Not always payments in non-profit organizations
Attract managers & employees:
- Not only about getting the right people
- Compete by paying employees higher fixed pay
- Compete by paying employees a bonus
- Risk that competitors copy pay
- Risk of costs gets to high
Keep managers & employees:
- High costs to employ & train new personnel
- Not only monetary compensation: E.g Interesting work tasks & pleasant working environment
Credit:
- Recognition for good performance
- Comparison & competition with peers
- Often change when figures get public
- CEO can compare their salary with competitor CEO´s
Effort:
- May conflict with inspiration: Pressure = Less inspiring
- Important role of incentive system in agency theory
Inspiration:
- May be increased by incentives
- Inspired, creative & smart managers make better decisions, ideas, think in new ways & inspire others
- May conflict with effort: No pressure = More inspiring
Goal congruence:
- Aligned goals of individual, department & company
- Work in line with company mission, goals & strategies
- Everyone working to reach the same
- Difficult to achieve: Especially in large organizations
- Incentive systems often align goals of different individuals & departments
- Can also be created by input controls: Shared values & common culture
Flexible remuneration (aflønning):
- Variable pay: Pay linked to performance
- Important not to loose personnel in bad years
- Shared performance risk between owner & managers
(!) Describe the different types of incentives and motivators
Basic salary:
General:
- Fixed pay: Don’t depend on performance
- Fixed for certain period: E.g. Revised every year
- Fixed pay tend to increase instead of decrease
- Revision can have negative or positive effects on motivation due to communication/how it is carried out
Good basic salary:
- Employees feel appreciated & valued
- Can lead to motivation
Not good basic salary:
- Negative effects on motivation
____________
Short-term variable pay:
General:
- Variable pay depend on some performance measures
- Relation between measures & payments
- Often include threshold & upper ceiling
Pay on percentage of profit:
- Often after specified return: Low profit = still bonus
- Often based on equity or capital employed
Pay on earnings per share:
- After predetermined level
Pay on profitability relative to industry:
____________
Deferred pay:
General:
- Bonus one year is paid over period: Often 5 years
- Spread of gains encourage long-term decisions
- Encourage staying if bonus taken away if quitting
- Risk of weaker incentive
____________
Stock options:
- Put manager in a shareholder position
- Right to buy number of shares at or after a given date (exercise date) in the future at the price agreed upon at the time the option is granted
Advantages:
- Encourage long term value creation
- Attract talented employees
- Reduce other pay components
Critiques:
- Controllability problem
- High risk
- Uncertainty
____________
Intrinsic incentives:
- Non-financial aspects to employee satisfaction
- Interesting, meaningful & challenging tasks
- Work or employee satisfaction create motivation
- Focus on work task, environment & colleagues
- Sometimes more important than financial incentives
- Products & services has larger meaning
- Sustainable company choices can create meaning
- Kinship: Liked team working toward common goals
- Teamwork seen as stimulating & rewarding
Name the two most popular theories of motivation an describe the difference between them
Theories:
- Agency theory: Rooted in economics
- Self-determination theory: Rooted in psychology
General:
- Those impacting incentive system design most
- Those mostly used in practice
- Those most debated on
- Represent two camps
- Very different from each other
- Often humans has both theory X & theory Y
- Combination of economy & psychology
________________
Theory X and theory Y:
General:
- Different and opposing views on motivation
- Theory X relates to agency theory
- Theory Y relates to self determination theory
Theory X human view:
- Having instinctive aversion to work
- Lazy
- Needs forcing
- Needs control
- Avoid responsibility
- Prefers to be led by others
Theory Y human view:
- Work as natural as rest
- Lead & control own work if important purpose
- Desire of responsibility under right circumstances
- Inventiveness is common
- Ability to work autonomously is common
________________
Differences between the two theories:
Type of work task:
Simple, repetitive and boring work tasks:
- Extrinsic motivation
- Relates to agency theory
- Alternatives for creating motivation: Decentralization of responsibility, broadening work tasks, implementing team work or job rotation
Complex, changing and challenging work tasks:
- Both intrinsic and extrinsic motivation
- Confusion about theory choice
Type of people:
- Consider which people & culture to attract
- Competitive people: Performance based salaries
- Cooperating people: Collective bonuses
- Some professions consider financial incentives natural why it is needed due to competition
Beliefs:
- Based on different beliefs
(!) Describe the agency theory in general, why it is important and its critiques
General:
- Rooted in economics
- Systems often influenced by it in some way
- Popular due to simplicity & clear logic
- Humans seen as rational
- World of two-people explicit or implicit contract
- Principal delegate decision making authority to agent
- Agent performs services
- Agent is utility maximizer, motivated by self interest
- Principal expect agent to act in their best interest
- Both shareholders, owners & CEO can be principal
- Both CEO´s & managers can be agents
- Big influence especially for TM if stock listed
- Related to theory X: Need of forcing & control
- Writing contracts & incentives motivate individuals to behave in goal-congruent way
_____________
The importance of agency theory:
General:
- Due to emerging separation of owners & managers
- How owner ensure manager act in best interest
Suggestions for CEO´s:
- CEO´s as substantial owners of stocks in company
- CEO´s salary, bonus & stock options should be provide big rewards for superior performance & big penalties for bad performance
- CEO´s should often be dismissed for bad performance
_____________
Critiques against agency theory:
- Wrong basic assumptions about human rationality
- Wrong basic assumptions about act in self-interest
- No promotion of ethical behavior
- Don’t consider people may act on moral standpoints
- Incentives tend to increase moral hazard
- Modern approaches include moral costs
Describe the difference between financial wealth and human capital
Financial wealth:
- Increases with good performance
Human capital:
- Increases with good performance
- CEO more attractive if good track reports
(!) Describe the different considerations in agent theory
Principals and agents divergent objective & preference
General:
- Can be reduced by incentive systems
- Divergence in risk preference
Agents general:
- Individuals act in their own self-interest
- Work adverse = Prefer leisure over effort
- Shirking = Deliberate withholding efforts
- Satisfaction from financial compensation, leisure time, attractive working conditions & flexible work hours
Agents risk preference:
- Prefer more wealth to less
- Marginal utility/satisfaction decrease as more wealth
- Risk-averse: Can’t diversify from risk as the owners
Principals general:
- Only interested in return accrued from investment
Principals risk preference:
- Risk-neutral
- Diversify risk by owning shares in many companies
_____________
Non-observability of agents actions:
Moral hazard:
- Agents motivation to misrepresent private info
- Due to divergent preference of principal & agent
Information assymmetri:
- Principal has inadequate info about agents effort
- Agents contribution to company results not certain
Private information:
- Agents knowledge about goal-congruence working
- Agents may know more about the task
_____________
Monitoring and incentives:
General:
- Handle divergent objectives & information asymmetry
- Monitoring & incentives are not mutually exclusive
- Agency costs: The added compensation costs
- Never ensure complete goal-congruence due to different risk preference, information asymmetry & cost of monitoring
Monitoring:
- If task is well defined
- If information or signal in monitoring is accurate
- Principal can design system monitoring agent action
- E.g. The audited financial statement
Incentive contracting:
- If task is not well defined
- If information or signal in monitoring is not accurate
- Attempt to limit divergence preferences
- Performance measures must be goal-congruent
- If performance measure not closely related to agents effort = Little incentive for agent to increase effort
- If only a basic salary less motivation to work
_____________
CEO compensation & stock ownership plans:
General:
- Preferred to contract if not other incentive features
- Add additional risk to the already risk-averse agent
- Less agency cost than basic salary
- Contract has to increase expected pay to compensate
Negative consequences:
- Risk of no high-risk projects since already risky
- No relation between agents effort & stock price
- Managers expect higher salary to compensate for risk
_____________
Responsibility centre managers & accounting-based incentives
General:
- Managerbonus depend on RC profit
- Less agency cost than basic salary
Negative consequences:
- Agent may inflate profit with accounting manipulation
- Lack of controllability: Competitor strategy & entrants
(!) Describe the self determination theory in general and the critiques to it
General:
- Rooted in psychology
- Less impact than Agency theory
- More complex & harder to understand
- Humans with bounded rationality
- Include both material, social & emotional needs
- Solid foundation in experimental research
- Motivation theory used today for most consultant
- Both extrinsic & intrinsic motivation and relation
- Analyze drivers of intrinsic motivation
- Introduces crowding out effects
- Often used when criticizing Agency theory
- Related to theory X
____________
Critique against self-determination theory:
- Not in line with experience: Self selection argument
- Often managers feel agency theory is more in line: Positive outcomes more obvious
- Findings from experiments not so generalizable
(!) Describe the different considerations in self determination theory
Extrinsic motivation:
- Satisfaction from the gains to carry out certain task
- E.g. Monetary reward
______________
Intrinsic motivation:
General:
- The satisfaction of carrying out a certain task or goal
- Rarely seen in boring jobs
- If none, no difference to agency theory
- Works better in intellectually demanding tasks
- Works better when need of creativity & innovation
- Works better when there is a learn-objective
______________
Crowding-out:
- When manipulating
- When already strong internal motivation
- When external motivation is manipulative/controlling
- More total motivation if extrinsic motivation removed
- Less total motivation if adding extrinsic motivation
- No crowding out if unexpected or no link to behavior
- E.g. Manager less motivated to perform if bonus
Reasons:
Impaired self-determination:
- External control limits a persons freedom & autonomy & might therefore conflict with the intrinsic motivation
- Individuals perceive having decreased autonomy due to external intervention: Crowd out intrinsic motivation
Impaired self-esteem:
- Bonus seen as an element of distrust
- Feeling of not being trusted without incentives
- Crowd-out intrinsic motivation
- Imposing external rewards implies that a person’s own involvement & motivation is not enough
______________
Crowding in:
- When external motivation is seen as supportive
- More total motivation if extrinsic motivation added
- Less total motivation if extrinsic motivation removed
- E.g. Manager walks around
Describe the principal-agent-framework
Principal:
General:
- Design contracts with monetary incentive to agent
- Residual claimant of relationship
Objective:
- Risk neutral
- Maximize residual of the relationship = y - w
Information:
- Observes performance
- Don’t observe agent effort, decisions, external effects
- Only use imperfect signal of agents effort
- Conflict of interest in relation to agent
- Information asymmetry in relation to agent
Imperfect signal:
Performance = effort + noise –> y = e + epsilon
____________
Agent:
General:
- Actions & effort influence performance of relationship
- Prefer leisure over work
- Act under the contract
- Suffers from effort disutility: C(e) = e^2/2
- Often both fixed & variable pay: w = Beta_0 + beta_1*y
- Only accept contract if certainty equivalent > 0
Objective:
- Effort/work aversion
- Maximize personal utility = Wage - cost of effort
- Conflict of interest in relation to principal
- Maximize certainty equivalent of utility function
- Risk avers with constant rate of absolute risk aversion, r
Information:
- No lack of information
- Information asymmetry in relation to principal
Certainty equivalent:
- Max CE = Wage - Work or effort - risk
- Wage = Beta_0 + Beta_1 * e
- Work/effort = e^2/2
- Risk = r/2 * Beta^2_1 * sigma^2
- B_1 = 1/1+r*sigma^2
____________
Trade-off
- Trade-off between proper incentive to motivate effort & the risk agent bear within incentive contract
Describe some intrinsic motivation drivers
General:
- Advanced & complicated task
Financial compensation:
- Good basic pay show fairness & acknowledgement
- Collective bonus strengthen team spirit
Interesting assignments:
- If personal interest, work itself will be rewarding
- Hire personnel with interest in job not money
- Important broad & varied work tasks
Competence development:
- Good for both the employee & organization
- Opportunity for employees to become better
- Often limited in many organizations
Communication:
- Manager walking around
- Manager noticing, informing & listening
- Relates to involvement
- Favorable to use personal relations
Involvement:
- Being listened to
- Being taken into consideration
- Having change of influencing decisions
- Make people feel like part of something bigger
- Gives meaning to work: More rewarding
- Strengthen commitment & motivation
- Reference to bottom up
Autonomy:
- Autonomy on how to perform ones own tasks
- Demotivating if manager knowing less interrupt
Affiliation:
- Collective rewards often increase team spirit
- Often strong motivator together with kinship
- Rewarding to reach goals & gain succes with people person has a strong bond to
Relate the topic to the case Animation Corp
General:
- Before -> New CFO -> Back to roots
Before:
- Depending on creative environment
- Flat hierarchy
- Focus on input controls: selection of employees
New CFO:
- Cost-efficient growth
- Focus on output and throughput controls
Back to roots:
- Team asked to cut cost aligned to values themselves
- Offered training in cost management
__________
Intrinsic motivation:
- Collaborative and empowering
- Strong team spirit + Belongingness
- Senior manager easily approachable
- Pay better than industry standard
- Collective rewards
- Selecting most talented and dedicated candidates
__________
Factors undermining intrinsic motivation:
- Focus on effective time
- '’What you measure is what u get’’
- Two hours help to others per month
- Employees ranked: Top, standard or low
- No trust
__________
Drivers for intrinsic motivation:
Competence: Employee selection
Relatedness: Belongingness
Autonomy: Free in artistic expression
