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Evidence on Responses to Within-Firm Incentives

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Evidence on Responses to Within-Firm Incentives a) Within Firms only: - Safelite Glass Company (Lazear 2000) - “Pay Enough or Don’t Pay at All” (Gneezy and Rustichini 2000) - “High Stakes and Big Mistakes” (Ariely et al., 2009) - “The Hidden Costs of Control” (Falk and Kosfeld 2006) b) Implications for Labor Markets: -Fehr, Kirchsteiger and Riedl (1993) -Brown, Falk and Fehr (2004)2 Lazear, E. P. “ Performance Pay and Productivity” American Economic Review 90(3) (December 2000): 1346-1361. Safelite Glass Co, Columbus Ohio Largest installer of auto glass in U.S. Employees work independently; no interactions; output easily measured (quality was handled separately). Employees were paid on an hourly basis, independent of output. Lazear convinced the CEO to introduce piece rate compensation in mid-1990s. The new compensation system was introduced on a staggered basis in locations across the country, allowing many before-after comparisons involving 2000 workers.3 Predicted effects of introducing piece rates: Under straight hourly pay, imagine that a worker needed to produce Q0 to keep his job. No financial incentives were provided for additional output beyond Q0. Thus, we expect both ‘lazy’ and ‘ambitious’ workers to produce Q0. Pay under the new scheme was identical to the old, except that workers who produced more than Q´ were rewarded a fixed amount for every additional windshield installed. So we expect ambitious workers, but not lazy workers, to raise their output. Put a different way, both the mean and the variance of output should rise. Output (Q) Reward schedule before piece rates were introduced Indifference Curves of a ‘lazy’ worker ∙ Indifference curves of an ‘ambitious’ worker New policy added this segment to the reward schedule Q0 Q1 Base pay Q´ Income(Y)Output (Q)4 Results: -variance of output rose; ‘abler’ workers increased their output more -profits and wages both rose -average output rose by 36% -the average worker increased his output by about 18% What accounts for the difference?5 Lazear’s data allowed him to: a) compute average output per worker before and after the change—this increased 36% b) compute the change in output for those workers who were at Safelite both before and after the change-- this increased only half as much Thus: half of the increase in output was due to turnover—a different mix of workers before and after the change. The new scheme was more attractive to ‘ambitious’ workers, so: -they were more likely to stay than ‘lazy workers’, and -new hires were, on average, abler. So: Changes in pay policy affect not only existing workers’ effort choices, but the mix of workers attracted to the firm. HRM innovations can generate massive productivity improvements.6 Gneezy, U. and A. Rustichini, “Pay Enough or Don’t Pay at All”. Quarterly Journal of Economics 115(3) (August 2000): 791-810. Two experimental tests where subjects were paid by the piece to perform a task. What is the effect of the piece rate on performance? Focus on the “IQ test”: college students paid per question answered correctly (out of 50). Subjects all received the same ‘base pay’ (60 NIS show-up fee), then were randomly assigned to be paid piece rates per correct question, ranging from 0 to 3 NIS (just under $1 at the time) per question. Mean performance was: Payment per correct answer (b): 0 0.1 1.0 3.0 Mean performance 28.4 23.1 34.7 34.1 Performance was worse for small rewards than for no reward at all. (similar results from a field experiment involving door-to-door solicitation). Further: college students do not expect people to behave this way: When student “principals” had to choose between paying 0 and 0.1, 87% chose 0.1!7 Possible Explanations: - Monetary rewards destroy ‘intrinsic motivation’? (Possible, but the effect must be discontinuous). - “Incomplete contracts”: Offering the reward changes workers’ perception of the labor contract: If a zero piece rate is offered, subjects tend to perceive the ‘contract’ as follows: “The experimenter has offered me 60 NIS to do a job. Now I know what that job is –answering questions—and it is my job to do it satisfactorily.” [put a different way—subjects interpret this as a gift-exchange contract] If a positive piece rate is offered, subjects tend to perceive the contract more as follows: “The experimenter has offered me 60 NIS to show up. I’ve done that. Now he is offering me 10 cents per question to answer questions. That’s not very much.”8 Lesson: When labor contracts are ‘incomplete’ (which is almost always the case), perceptions and ‘framing’ of what is expected/owed/fair can matter a lot. They can also be hard to change. See for example: -Gneezy-Rustichini’s daycare experiment (first introduced, then removed a fine for late pickup). Lateness increased, and never recovered. -Irlenbusch and Sliwka (IZA working paper no. 1758, Sept. 2005). ‘chosen effort’ lab experiment [no intrinsic motivation likely here]; first they introduce an option for principals to pay a piece rate, then remove this option. Effort fell, then fell even further.9 Ariely, Dan; Gneezy, Uri; Loewenstein, George; Mazar, Nina. “Large Stakes and Big Mistakes” Review of Economic Studies, vol. 76, no. 2, April 2009, pp. 451-69 In 2009, Dan Ariely and co-authors conducted experiments on how financial incentives affect performance in 6 simple tasks: -“Packing quarters” (creativity) -“Simon” (predecessor to “Bop-It”) and “Recall Last Three Digits” (memory) -“Labyrinth”, “Dart Ball” and “Roll-up” (physical)10 The experiments were done in a rural town in India, and compared the effects of “low”, “medium” and “high” incentives on performance. Low incentives: 4 rupees for “very good” performance Medium incentives: 40 rupees for “very good” performance High incentives: 400 rupees for “very good” performance. This is about equal to one month’s earnings in the village. Their hypotheses: -going from low to medium incentives might raise performance, but from medium to high might reduce it, due to ‘choking’ -‘choking’ is more likely for creativity and memory tasks, less so for physical tasks. Their results: [insert Ariely et al.


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