Joe Mahoney University of Illinois at Urbana-Champaign Economics, Organization and Management Chapter 12: Compensation and Motivation Joe Mahoney University of Illinois at Urbana-Champaign

Milgrom and Roberts (1992): Chapter 12 Economics, Organization & Management Explicit Incentive Pay Piece-rate systems involve paying employees a specified amount per unit produced. Advantages include: Encourages hard-working workers; Ties may directly to performance; Attracts more productive workers; Encourages workers to improve skills; Compensation based more on objective measures.

Milgrom and Roberts (1992): Chapter 12 Economics, Organization & Management A major difficulty with piece-rates is that paying for output alone encourages employees to ignore other valuable activities. Piece-rate workers will be tempted to reduce quality to increase measured quantity. They will be unlikely to help other workers if it means reducing their own measured output. The quality problem can be mitigated by close quality inspection, coupled with charging workers for flaws and failures and/or making them personally responsible for reworking defects on their own time.

Milgrom and Roberts (1992): Chapter 12 Economics, Organization & Management Sales Commission. Incentive pay based on explicit formulas is very widely used in compensating salespeople, who regularly receive part or all of their pay through commissions. Greater sales result directly in higher pay for the salespeople, thus motivating them to focus more energy, diligence, and imagination on their jobs. As with piece-rates, commissions also induce self-selection.

Milgrom and Roberts (1992): Chapter 12 Economics, Organization & Management Incentive Pay for Groups of Employees Profit sharing plans Gain sharing plans E.g., Nucor

Milgrom and Roberts (1992): Chapter 12 Economics, Organization & Management Effectiveness of Group Incentive Contracts Determining individual contribution is difficult or impossible. For example, how is the contribution of a single member of a design team measured? Groups of workers often have much better information about their individual member’s contributions, and group incentives then motivate the employees to monitor one another and to encourage effort provision or other appropriate behavior. Group incentives encourage cooperation.