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C&B > T01 Huck et al. (2011): Deferred Compensation > Flashcards

T01 Huck et al. (2011): Deferred Compensation Flashcards

1
Q

What is a deferred compensation contract?

Huck et al. (2011): Deferred Compensation

A

… workers are underpaid during the early part of their career and overpaid during the later part of their career.

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2
Q

Why would a manager choose a deferred compensation scheme?

Huck et al. (2011): Deferred Compensation

A
  1. Observability of effort: Effort is costly to observe or cannot be observed.
  2. Long-term relationship: Worker-relationship is expected to be long-term.
  3. Reducing turnover rates: It motivates people to stay in the firm.
  4. Discount rate: Attracting workers with low discount rates
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3
Q

What are the incentives of a deferred compensation scheme for the worker and the firm? What is the implication and what are the solutions?

Huck et al. (2011): Deferred Compensation

A
  • Worker increase their effort in order to maintain in the firm because future expected pay exceeds outside option.
  • Firm reneges on late-career overpayment because older workers are paid above their marginal productivity
  • Implication: If there is no commitment mechanism there will be no deferred compensation scheme
  • Solutions: legally binding contracts and reputation building
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4
Q

Why did the authors use a labarotary experiment, why is randomness important and what is the main disadvantage of a lab experiment?

Huck et al. (2011): Deferred Compensation

A
  • Testing the theory on observational data is difficult:
    • Steep earnings due to monitoring difficulties
    • Pensions designed to retain and motivate
    • Flatter wage profiles due to mergers or high bankruptcy costs
    • Productivity increase in later career
  • Importance of random assignment:
    • subjects differ exclusively by treatment
    • allows to draw causal inferences
  • Disadvantage: Lack of external validity => simulate real environment
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5
Q

What was the experimental design? (5 aspects)

Huck et al. (2011): Deferred Compensation

A
  1. 10 subjects randomly assigned ‘worker’ or ‘firm’
  2. 20 rounds á 3 career stages
  3. Firm offers wages W=(W1,W2,W3)
  4. Worker chooses e1,e2,e3=(low, medium, high)
  5. If e=low, worker may get fired
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6
Q

What are the treatment groups?

Huck et al. (2011): Deferred Compensation

A
  1. FCT (Full Commitment Treatment): Firms can fully commit to W2 and W3.
  2. NCT (No Commitment Treatment): Firms cannot commit to W2 and W3.
  3. CFT (Computer Firm Treatment): Computers offer the same W2 and W3 as humans in FCT.
  4. RT (Reputation Buliding Treatment): Firms cannot commit to W2 and W3 but worker know the history of the firm.
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7
Q

What are the orthodox predictions for the 4 treatments?

Huck et al. (2011): Deferred Compensation

A
  1. FCT:
    • Never e=high, e=medium if…
    • Stage 1: 2W2+W3≥80 or W2+W3≥60
    • Stage 2: W3≥40
  2. NCT:
    • Always low effort
  3. CFT:
    • Same as FCT
  4. RT:
    • depending on modeling approach
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8
Q

Explain the 2 social preferences used in the paper and how they measure it.

Huck et al. (2011): Deferred Compensation

A
  1. Reciprocity (pos. W11-coefficent): In response to friendly actions, people are much nicer and more cooperative than in orthodox model. Conversely, much more nasty and even brutal in response to hostile actions
  2. Inequity aversion (neg. Fehr-Schmitt rationalizable): People resist inequitable outcomes. They give up own payoff in the direction of more equitable outcomes.
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9
Q

What are the behavioral predictions for the treatments?

Huck et al. (2011): Deferred Compensation

A
  • FCT: Reciprocal workers may exert e=high if W1,W2,W3 are perceived as a gift:
    • W1>0
    • 2W2+W3>80 or W2+W3>60
    • W3>40
  • FCT: Inequity averse workers may exert e=low even if
    • 2W2+W3≥80 or W2+W3≥60
    • W3≥40
    • holds but W1+W2+W3 < 100.
  • CFT: Reciprocal and inequity-averse workers behave as predicted by orthodox model
  • Firms pay W1=0 and W2,W3=(60-100,0)
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10
Q

Sketch the predictions graphically.

Huck et al. (2011): Deferred Compensation

A
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11
Q

What is the econometric method the authors used?

Huck et al. (2011): Deferred Compensation

A

Multinomial logit regression

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12
Q

How to read the table?

Huck et al. (2011): Deferred Compensation

A
  • W11: Reciprocal behavior (+ and sign.)
  • W12+W13: Incentive effect of deferred pay on effort
  • Lazear line: Increase in effort @Lazear line?
  • Lazear line x (W12+W13): Incentive effect of deferred pay if medium effort is incentivized
  • Fehr-Schmitt-Rationalizable: Inequity aversion (if -)
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13
Q

What does the table look like?

Huck et al. (2011): Deferred Compensation

A
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14
Q

What are the 5 results of FCT?

Huck et al. (2011): Deferred Compensation

A
  1. Workers exhibit reciprocal behavior
  2. Deferred pay affects e1
  3. Lazear line matters for effort decision
  4. Deferred pay is less effective if medium effort is incentivized
  5. Workers exhibit inequity aversion, which may lead to e=low
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15
Q

What are the 4 results of CFT?

Huck et al. (2011): Deferred Compensation

A
  1. Workers show no reciprocal behavior
  2. Deferred pay affects e1
  3. Increase in effort @Lazear line
  4. Deferred pay is less effective if medium effort is incentivized
  5. Workers show no inequity aversion towards computers
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16
Q

What are the 2 results of NCT?

Huck et al. (2011): Deferred Compensation

A
  1. Workers show reciprocal behavior
  2. Deferred pay does not affect e1
17
Q

What are the 3 results of RT?

Huck et al. (2011): Deferred Compensation

A
  1. Workers show reciprocal behavior
  2. Deferred pay does not affect e1
  3. Good reputation is more important than just promises
18
Q

What are the 3 results in earnings and social surplus (efficiency) in the 4 treatments?

Huck et al. (2011): Deferred Compensation

A
  1. Worker earn most when firms can commit
  2. Social surplus is highest when firms can commit
  3. Reputation building achieves some social surplus gains
19
Q

What are the 4 conclusions of the paper?

Huck et al. (2011): Deferred Compensation

A
  1. Deferred compensation works only if firms can commit to it
  2. Alternatively, reputation building helps a little
  3. If neither is possible, gift exchange increases effort of reciprocal workers

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