Performance based incentives Flashcards
Level of effort depends on marginal benefit and not:
Level of pay
How can a firm increase profits using pay rates?
Increase commission rates and lower the base of pay
Performance based pay allows the employee to exploit:
Their private information
What are the two problems with high powered incentives
- Performance measure is affected by random factors
- Measure fails to capture all aspects of desired performance
If people are risk averse, they can improve their situation through:
Risk sharing
The principle behind insurance is:
The pooling of uncorrelated risk
Pooling and sharing can reduce the variability without decreasing the:
Expected value
If one person is risk neutral and one is risk averse, the risk should be:
Traded away to the risk neutral person
The incentive component of pay can be made stronger if:
- Employee is less risk averse
- Variance of performance measurement is smaller
- Employee is less effort averse
- Marginal return to effort is higher
Activities detrimental to the firm may be undertaken by staff due to them having a positive effect on:
Performance measures
What are possible solutions for the costs of pay-for-performance
- Delink pay and performance
- Redesign jobs to ensure rewards don’t neglect key tasks
- Use subjective performance evaluation along with direct monitoring
A good performance measure should:
- Not have a huge random component
- Should encourage desirable activities
- Should discourage undesirable activities
The choice for performance measures should be between:
Narrow (individual) and broad (Firm’s profit)
Compensation plans affect the way employees:
Make decisions
What are 4 incentive mechanisms
- Implicit contracts
- Subjective evaluation
- Proportion tournaments
- Threat of termination
