Human Capital Incentives?

Mario MacisJohns Hopkins University

Carey Business School

JHU Carey Alumni WebinarSeptember 29, 2014

Why link pay to performance?

• Align workers’ interests to employer’s− Standard tool from agency theory

• Selection− High-powered incentives attract more productive individuals

• Retention− Highly productive workers will leave if not rewarded according to their contribution to

firm value

• Better assignment of workers to tasks− One of the benefits of measuring performance

• Fairness− Employees should be given (at least part of) the extra value they contribute to create

Getting incentives right is hard

1. Need to come up with good performance measure (PM)– Ideal PM measures worker’s contribution to firm value, and nothing else– However, in practice…

PM just a noisy proxy PM might not capture all relevant tasks PM can be gamed (by both worker and employer)

2. Need to choose the shape of the pay-performance relationship– Commission? Lump-sum bonus if worker meets quota? Raise? Promotion?

3. Need to do a good job evaluating performance– Quantitative indicators?

Do they “objectively” reflect performance?

– Subjective evaluations? Evaluate fairly, avoid bias, favoritism, …

Evidence confirms: incentives can be good, bad, ugly

• Positive effects on productivity, selection/retention– Agricultural workers (Bandiera et al. 2007; Bandiera et al. 2012; Moretti and Perloff

2002; Shearer 1996; Shearer 2004); Repair technicians (Lazear 2000; Lazear and Shaw2007); IT service workers (Gibbs et al. 2014); Teachers (Duflo et al. 2012); Schoolprincipals (Miller et al. 2012); Academic referees (Chetty et al. 2014); Health workers(Bossuroy et al. 2014); Blood donors (Lacetera et al. 2013).

• Evidence of “distortions” and “gaming”– Navy recruiters (Asch 1990); Salespeople, managers, executives, professionals (Oyer

1998); Bankers (Obloj and Sengul 2012); Software salespersons (Larkin 2014); Teachers(Jacob and Levitt 2003).

Design details, specific context matter a great deal: mixed evidence not a surprise

Cannot draw general conclusions from any individual study

Crucial to accumulate evidence from multiple contexts

Lincoln Electric vs. Roy’s Plant

Lincoln Electric (Berg and Fast, 1983)

•Manufacturing workers•Piece rates (W=bQ)•Workers penalized for defects

Highly successful• Industry leader, etc.• Workers source of

product/process improvement

•Open communication•Culture of trust•Guaranteed employment•Company-wide bonus

Roy (1952)•Manufacturing workers•Piece rates (W=a+bQ)•Workers penalized for defects

Highly dysfunctional• Workers did bare minimum,

gamed incentive scheme• ½ potential productivity

•No communication•No trust•Zero-sum game (us vs. them)

What about “intrinsically motivated” agents?

• Do we still need to provide incentives if the agents are “intrinsically motivated”?− Yes, because intrinsic motivation might lead agents to take undesirable actions− Yes, because intrinsic motivation does not guarantee the employee has the right skills

• But, how do extrinsic incentives interact with intrinsic motivation?− Incentives can increase the supply of the desired behavior (Arrow 1972; Solow 1971)− Incentives can reduce the desired behavior

− if they “crowd out” intrinsic motivation (Deci 1971)− if they create doubts about the reason(s) behind the action (Benabou and Tirole 2006)− if they create psychological pressure on the agent that leads to “choking” (Baumeister 1984)− if they change the nature of the relationship/implicit contract (Gneezy and Rustichini 2000)− If they invite peer comparisons (Larkin, Pierce and Gino 2012)

• Theory is ambiguous → Empirical analyses needed

Selected evidence from the “lab”

“The candle problem”– Glucksberg 1962

• Incentives for “thinking outside the box”.N = 139 lab subjects.

• Incentives worked when problem framed asmore straightforward (tacks outside box)

• Incentives backfired when problem framed asless obvious (tacks inside box)

Large stakes and big mistakes – Ariely et al. 2009

• “Lab in the field” in India (N = 87) and lab at MIT (N = 24).• Variety of tasks (packing quarters, Simon, labyrinth, darth ball, etc.)• Very large incentives (≈ one month avg. living standard) worsened performance• Evidence of “chocking under pressure”

Selected evidence from the field

Rewards for blood donors (Lacetera, Macis, Slonim 2014)

• Effect of economic rewards ($5, 10, 15 gift cards)• Large-scale natural field experiment; 72 drives, ~100K Red Cross donors contacted• Large, positive effect on donations, increasing with the $ value of the reward• No evidence of crowding out (effect stronger for more frequent, long-term donors)• Evidence of social spillover effects and substitution effects

Rewards for academic referees (Chetty, Saez, Sandor 2014)

• Field experiment at theJournal of Public Economics

• 1,500 referees, 2010-2011• $100 cash incentive for

submitting within 4 weeks• Cash reward had largest

positive effect on turnaroundtime

• No evidence of crowding outof intrinsic motivation (cashsubjects do not become slowerafter incentive is removed)

• No effect on quality (editorfollowing the ref’srecommendation)

• No spillovers to other journals• Cash reduced the length of the

report

Rewards for new ideas?

• “Ideation” increasingly important in modern economies

• Not just in R&D labs: employees at any level can potentially come up with ways toimprove products and processes

• Many companies use a formal “suggestion system” (1/3 of workplaces in US and UK[Ohly et al. 2013])

“It pays off to think outside the box (…) Not only do the company and our customers profit from the innovative power of our employees, but also the employees themselves.”Margret Suckale, member of the Board of Executive Directors of BASF SE.

Rewards for new ideas (Gibbs, Neckermann, Siemroth 2014)

• Large Asian Tech company• Outsourcing of business processes,

R&D, software/hardware solutions forclients.

• Employees encouraged to submit ideas onprocess and product improvements via anonline “Idea Portal” (pre-dating the study)

• RCT involving 11,000 employees in 19key accounts

• Treatment: points (redeemable for consumer goods at online site) awarded for ideas submitted and approved, and for positive client feedback

• Reward discontinued after 13 months

Rewards for new ideas (Gibbs, Neckermann, Siemroth 2014)

• Large Asian Tech company• Outsourcing of business processes,

R&D, software/hardware solutions forclients.

• Employees encouraged to submit ideas onprocess and product improvements via anonline “Idea Portal” (pre-dating the study)

• RCT involving 11,000 employees in 19key accounts

• Treatment: points (redeemable for consumer goods at online site) awarded for ideas submitted and approved, and for positive client feedback

• Reward discontinued after 13 months

Findings:1. Increased participation in the Idea Portal

(share of employees submitting ideas).

2. Fewer ideas submitted per potentialcontributor; No effect on total ideasactually submitted.

3. Higher quality of submitted ideas– % of ideas accepted for implementation– % of ideas pitched to the client.

4. No evidence of crowding out: treatmenteffects were no less positive on priorideators.

5. Participation effect persisted after therewards were removed; quality effectdisappeared.

Why do lab and field study tend to differ?

Some possible reasons:

1. Results from subjects in laboratory experiments (typically college students) mightnot always extend to real-world settings.

2. People sort into occupations also based on the structure of compensation– E.g., average persons in a lab (or lab-like) experiment might “choke under pressure” when

presented with large monetary incentives to perform tasks, but people who choose to workin industries/positions with strong pay for performance would presumably responddifferently

3. Experimenter effects/Social desirability bias(es): Subjects who are aware of beingpart of a study might feel pressure to:

– adhere to social norms; e.g., people perform certain jobs because it is their “duty” to doso, not because of monetary incentives

– conform to stereotypes; e.g. “creative people are not motivated by money” (Kim 2012)

What about employee recognition?

“I have been salesman of the month for 13 out of the last 12 months. I did so well lastFebruary that corporate gave me two plaques in lieu of a pay raise.”Dwight K. Schrute, Assistant (to the) Regional Manager, Dunder Mifflin Scranton (PA)

The “Dirty Laundry” of awards (Gubler, Larkin, Pierce 2014)

• Attendance award program at oneindustrial laundry plant in US Midwest,2011. 276 workers at 5 plants.

• All employees with no unexcused absenceor tardy in previous month were:

1. Publicly announced at plant-wide meeting2. Eligible for a $75 gift card

• Positive effects on desired behavior• ↓ absent, ↓tardy, ↓minutes late

• But also evidence of gaming andundermining of intrinsic motivation:

• ↑ N. of unplanned “single absences”• Pre-award “perfectly punctual” employees

2.5x more likely to be tardy if disqualifiedin a given month

• ↓ efficiency of “high efficiency” workers

So, do incentives work?

Evidence from laboratory experiments indicates that incentives can backfire• However, beware of “experimenter effects” and “social desirability bias”

Evidence from field experiments shows that when designed well, incentives dostimulate the desired behavior

Recent field evidence finds positive effects in tasks/occupations where “intrinsicmotivation” is important

• If designed and framed appropriately, incentives can complement intrinsic motivation

Relevant question should be: under which conditions do incentives work/do notwork

One size does NOT fit all! Companies should run experiments to test theeffectiveness of new incentive schemes in their organization

• Consider small-scale experiments before rolling out company-wide changes: can learnwhat works and what doesn’t and avoid costly mistakes

References

Ariely, D., Gneezy, U., Loewenstein, G., and Mazar, N., 2009. Large Stakes and BigMistakes, Review of Economic Studies (2009) 76 (2): 451-469

Asch, B.J., 1990. Do incentives matter? The case of navy recruiters. Industrial andLabor Relations Review 43, 89–106.

Boning, B., Ichniowski, C. and Shaw, K., “Opportunity Counts: Teams and theEffectiveness of Production Incentives”, Journal of Labor Economics 25 (2007):613-650.

Chetty, R., Saez, E., and Sandor, L. 2014. “What Policies Increase Pro-Social Behavior?An Experiment with Referees at the Journal of Public Economics”, Journal ofEconomic Perspectives 28(3): 169-88, 2014.

Deci, E.L., 1972: “The Effects of Contingent and Noncontingent Rewards and Controlson Intrinsic Motivation,” Organizational Behavior and Human Performance 8, 217-229.

Duflo, Esther, Rema Hanna, and Stephen P. Ryan. 2012. "Incentives Work: GettingTeachers to Come to School." American Economic Review, 102(4): 1241-78.

Gibbs, M., Neckermann, S., and Siemroth, C. 2014. A Field Experiment in Motivating Employee Ideas, University of Chicago Working Paper.

References

Glucksberg, S. 1962. The influence of strength of drive on functional fixedness andperceptual recognition. Journal of Experimental Psychology 63, 36-41.

Gneezy, U., Meier, S., & Rey-Biel, P., 2011: “When and why incentives (don't) work tomodify behavior,” The Journal of Economic Perspectives, 191-209.

Gneezy, U., & Rustichini, A., 2000: “Pay enough or don't pay at all,” The QuarterlyJournal of Economics, 115(3), 791-810.

Gubler, Timothy, Ian I. Larkin, and Lamar Pierce. "The Dirty Laundry of EmployeeAward Programs: Evidence from the Field." Harvard Business School WorkingPaper, No. 13-069, February 2013.

Kamenica, E. (2012). Behavioral Economics and Psychology of Incentives. Annu. Rev.Econ., 4(1), 427-452.

Lacetera, N., Macis M., and Slonim, R., 2012. “Rewarding Volunteers: A FieldExperiment” Management Science, 2014, 60(5), pp. 1107-1129 .

Lazear, Edward, 2000: “Performance Pay and Productivity”, American EconomicReview 90(3), pp. 1346-1361.

Oyer, P., 1998. Fiscal year ends and nonlinear incentive contracts: the effect on businessseasonality. Quarterly Journal of Economics 113, 149–185

References

Shearer, B., 1996: “Piece Rates, Principal-Agent Models, and Productivity Profiles:Parametric and Semi-Parametric Evidence,” Journal of Human Resources, Volume31, Number 2, Spring 1996.

Shearer, B., 2004: "Piece Rates, Fixed Wages and Incentives: Evidence from a FieldExperiment", Review of Economic Studies, vol. 71, no 2, pp. 513-534