Pay and Performance Employment Contract Motivating workers Formal vs. implicit contracts Information asymmetries and cheating Signaling Self-enforcement Surplus Motivating workers Output/performance Pay Time-based pay with supervision

Motivating the Individual in a Group Fairness Group Loyalty Productivity and the basis of pay Employee preferences Variability of pay and risk Worker sorting Employer Preferences O-B:Individual incentives O-B:Group incentives (free-rider) – executive pay Hybrid: T-B with merit increases

Output-based vs Time Based Pay Basic Considerations Adverse Selection Moral Hazard

Basic Considerations Adverse Selection Moral Hazard

Output-Based Pay O-B Advantages: O-B Disadvantages: Incentives to produce more Attracts more productive workers Involves risk that may require a compensating differential O-B Disadvantages: Quantity vs. quality Effect on capital Short-run vs. Long-run “Ratchet-effect”

Time-based Pay T-B Advantages: T-B Disadvantages: Problem and reduced cost of measuring output Individual and group loyalty Lower risk – less compensating differential T-B Disadvantages: Adverse selection Moral hazard Reduced incentive

CEO Pay The Principal-Agent Problem – managers are not owners Pay-based on profits – SR vs. LR Stock Options – outside risk and avoiding risk Straight - time-based pay with merit Over time more CEO have been receiving stock options Collusion between BOD and CEO – Home Depot Home Depot

Other Methods Efficiency wages Tournaments Better workers More loyalty Less turnover and discipline problems (self-enforcement) Higher cost Tournaments Time-based with prize