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
Explicit incentive contracts are:
Contracts that can be enforced by a third party
What are disadvantages of incentive contracts?
- Ratings compression
- Personal relationship leads to hiding info
- Subjective judgements
What is a promotion tournament?
Winning one level gives the chance to progress in the next level
Firing as a punishment is more effective if:
- Firm has a higher wage rate than the market
- There aren’t enough jobs to substitute
Efficiency wages are useful when:
Monitoring is difficult
Action will only be undertaken by the team if:
TC < (Total benefit)/n
n = number of members in the team
What are 3 ways teams can be incentivised to complete team goals
- Team size kept small
- Team members given lots of time together to cooperate
- Teams can be structured so team members can monitor each other
