1. Lecture 4 Incentives
This lecture focuses on the reasons why monetary compensation is not invariably a fixed payment. The argument for not introducing uncertainty about monetary compensation is that exposing the employee to risk is costly to him. The arguments for making payments contingent on worker performance is that this might affect their behavior in two ways, what types of workers accept the job offer in the first place, and how they perform on the job.

2. How can employees be managed?
There are four main ways bosses induce their subordinates to do what they want them to:
Command, control and force.
Persuade, shame and coerce.
Deceive and trick.
Provide incentives.

3. Command and control
This is common in hierarchic structures such as the military, where there is a clear chain of command, and in war, little time to deliberate.
It also arises in production lines, where a process involving work duties must be integrated or coordinated with industrial processes using machinery.
Note that workers may willingly accept the challenge of performing in these settings, partly for compensation before, during and after the period of employment.

4. Persuasion, shaming and coercion
This is most effective when management knows the emotional and psychological vulnerabilities of their workforce.
It is common in military and police academies, college sport, and activism in political parties.
It does not necessarily involve duplicity: employees may understand their own vulnerabilities and when enrolling agree to be subjected to what some would describe as abuse.

5. Deception and trickery
This is more likely to work:
the longer the lie can be sustained
and the less recourse employees have to extract compensation or vengeance later.
Newly independent teenagers and young adults, the mentally handicapped, and illegal migrants seem more susceptible than other demographic groups.
It is most prevalent in illegal activities where legal recourse is almost nonexistent, such as:
illegal immigration and itinerant work
prostitution (sometimes combined with the above)

6. Incentives Incentive schemes:
reward employees for pursuing objectives they might otherwise disregard
are also used as a selection device by appealing to some groups of potential employees versus others.
Incentives are used in conjunction with the other methods. For example in the military forces, incentives are used to attract recruits, by subsidizing their education, and making life more attractive for their family during and after their term of employment.
This course will focus on the provision of incentives.
Nevertheless Assignment 1 is a case study in which all four management tools appear to have been used.

7. Do employees react to incentives?
An exhaustive study is clearly beyond the scope of this course but here are four pieces of evidence:
Navy recruitments peak just before a performance review and trough immediately after.
Training centers are paid annual bonuses for the rate at which their “graduates” find jobs. They maximize the speed at which their unemployable students graduate, subject to the constraint of not losing the bonus.
Team compensation increases the performance of the least productive members and reduces the performance of the most producitve members.
Employee productivity increases work harder when they given financial incentives.

8. When do recruiters work hard?
The Behavior of Navy Recruiters (Asch 1990).

9. Job Training Partnership Act (JTPA)
The JTPA pays training centers for all graduates plus the percentage finding employment shortly thereafter.
INCIDENCE OF DELAYED TERMINATION BY EMPLOYMENT PERFORMANCE OUTCOME
EMPLOYMENT RATE AT TERMINATION IN PROGRAM YEAR 1988
MONTHLY ENROLLMENT
AND TERMINATION COUNTS
Courty and Marschke (1997)

10. Team members monitor each other when it pays
Response of Telephone Operators to Team-Based Compensation (Hansen 1997).

11. Employees work harder when offered financial incentives
Profit Sharing and Productivity (Kruse 1993).

19. Measuring the importance of moral hazard
There are three basic ways to measure how the goals of shareholders (value maximization) differ from those of their managers (expected utility maximization over career).
We say a manager “shirks” if he pursues his own goals as if he has a fixed wage. We say a manager “works” if he pursues firm’s goals of expected value maximization:
Gross expected loss to firm in one year when manager “shirks”, instead of “works”, (denoted by b1).
Compensating differential to manager for “working” rather than “shirking” (denoted by b2).
Maximum amount shareholders would pay to eliminate the moral hazard problem for a perfect monitor to oversee the manager and ensure he “works” (b3).

22. Summary Employees rationally respond to incentives they face.
An important way of managing employees in the free modern world is to incentivize them.
Financial incentives are used to:
hire the most valuable job candidates
incentivize managers to reveal their knowledge
induce managers act in the firm’s best interests.
Exposing managers to imperfect signals of performance must be offset by compensation for risk, the opportunity cost of monitoring them.
Similarly, when managers and specialists are privy to valuable information, the firm pays them to reveal it.