Distortion and Risk in Optimal Incentive Contracts.
George Baker
Forthcoming, Journal of Human Resources
Abstract：Performance measurement is an essential part of the design of any incentive system. The strength and value of incentives in organizations are strongly affected by the performance measures available. Yet, the characteristics of valuable performance measures have not been well explored in the agency literature. In this paper, I use a multi-task model to develop a two-parameter characterization of performance measures and show how these two parameters distortion and risk affect the value and use of performance measures in incentive contracts. I show that many complex issues in the design of real world incentive contracts can be fruitfully viewed as trade-offs between these two features of performance measures. I also use this framework to analyze the provision of incentives in several specific environments, including R&D labs and non-profit organizations.本文来自优.文~论^文·网原文请找腾讯3249,114
1. Introduction
The provision of incentives to individuals and groups in organizations is one of the central problems in the economics of the firm. A long and varied literature considers the question of what optimal incentive contracts look like (see Gibbons 1998, for a review). Most of this literature examines the use of "risky" 论文网http://www.youerw.com/ performance measures, and as a result focuses on what Gibbons calls "the much studied trade-off between incentives and insurance." Yet, in most incentive contracts in the real world, risk is not a central issue: with the exception of stock-based plans for top executives, most compensation arrangements in fact impose very little risk on employees. In addition, as Predergast (2000) points out, the data do not confirm the existence of a trade-off between risk and incentives.
In many incentive contracts, the central issue is not risk, but what Steven Kerr calls "The Folly of Rewarding for A While Hoping for B”(Kerr 1975). Consider the incentive plan tried by Lincoln Electric to motivate typists in its secretarial pool: they paid a piece rate for each key stroked. (Fast and Berg 1975) The plan was abandoned when it was discovered that secretaries were spending their lunch hours tapping the same key over and over. Understanding this aspect of incentive contracting has been the objective of the so-called "multi-tasking" literature. This literature has been concerned not with risk, but with "distortion." The papers in this literature get the same result as those in the insurance literature: the firm reduces the strength of the incentive contract. But the reason is not to avoid imposing risk on the agent, but to avoid rewarding the wrong behavior.
The multi-tasking literature has evolved along two almost independent paths, one in economics and one in accounting. In economics, Holmstrom-Milgrom (1991) and Baker (1992) each develop models that show why principals avoid strong incentives for agents who face many effort margins. Holmstrom-Milgrom shows that 2383
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