Design Of Incentive Systems Research Articles

Benchmarking Performance

An important challenge in the design of performance measurement, accountability, and incentive systems is the establishment of relevant benchmark levels of performance, also known as performance standards. We review information economics literature and draw simple lessons for the construction of performance standards. We demonstrate the relevance of these lessons in the context of a job training government organization.

Performance Measure Properties and Incentives

We examine the effects of performance measure properties on incentive system design, using data on incentive contracts for auto dealership managers. The data include information on five properties: two indicators of risk; two indicators of distortion; and one indicator of potential manipulation. We find that these properties have important effects on incentive system design. First, firms appear to choose the “best” performance measure available along these dimensions, and use it for the most important (primary) formula bonus. Second, the properties of this primary performance measure are important determinants of the weight placed on the measure for explicit. Third, firms appear to use other performance measures to balance multitask incentives relative to the primary performance measure. Specifically, we find evidence that second and third bonuses are used to provide better incentives for cooperation and to reduce incentives for manipulation. Fourth, we present evidence that subjectivity, through discretionary bonuses based on subjective performance evaluations, and also through implicit incentives for promotions and other rewards, also appear to play the same roles.

Design of an incentive system for application in a creative organization

The present paper investigates an incentive problem (the method of providing incentives to members) in creative organizations, such as research and development departments, using a cybernetic model called the agency model. In such organizations, members appear to have their own individual objectives which are different from those defined by the organization, and so significant conflicts can exist. Therefore, the proposed model considers the objective of the individual, which is given no consideration in conventional models, and conflict between the objective of the individual and that of the organization. The principles of incentive system design (the effectiveness of the performance‐based wage system) are entirely different depending on whether the conflict exists.

The effect of national culture on management control and incentive system design in multi-business firms: evidence of intracorporate isomorphism

This paper examines whether variations in national culture at the business-unit level of multi-business firms that operate internationally trigger adjustments in the corporate management control and incentive systems (MCISs) to fit local business-unit circumstances. Although the results show that selected MCIS characteristics are attuned to business-unit national culture, further analysis of multi-level data reveal small business-unit effects relative to corporate effects. The presence of dominant corporate effects suggests that MCISs tend to be uniformly implemented within firms, rather than to reflect local business-unit conditions.

New Perspectives on Incentive System Design: Integrating the Theory of the Firm and the Theory of Individual Behavior

Classical incentive reward systems motivate employees, but because the designs of these systems neglect consideration of key factors, the rewards typically do not achieve the right degree of employee motivation. Adding insights from the effort-net return model of employee motivation and from the economic theory of the firm helps management achieve the proper amount of employee motivation. The slope of the employee's perceived reward function is most critical in coupling the interests of the firm with those of the individual.

Explaining the Assigned Goal-Incentive Interaction: The Role of Self-Efficacy and Personal Goals

This study was designed to replicate conceptually and to explain the goal-level vs. incentive-type interaction reported by Mowen, Middlemist, and Luther (1981) based on goal setting and social cognitive theories. Mowen et al. found that subjects performed more poorly with hard goals than medium goals under a bonus pay system, the opposite of what was found for a piece-rate system. In the present study, an hourly pay condition was added. Mowen et al.‘s interaction was replicated using a two-trial design in which subjects could obtain feedback about their ability to attain the incentive bonuses between trials. The experimental effects were completely mediated by personal goals and self-efficacy. Goal commitment was related to performance, but did not mediate the experimental conditions. The implications for the design of incentive systems are discussed.

The economics of nuclear accident law

Statutes restrict the application of common tort law to accidents at nuclear power plants in Canada, the U.S., and other countries. The statutes transfer to the operator of a nuclear plant liability that would otherwise be placed on input suppliers and in return limit the liability of the operator. This essay addresses the impact on safety incentives of nuclear accident law, with broader implications for the design of incentive systems that combine regulation and liability rules.

Explaining the assigned goal-incentive interaction: The role of self-efficacy and personal goals

This study was designed to replicate conceptually and to explain the goal-level vs. incentive-type interaction reported by Mowen, Middlemist, and Luther (1981) based on goal setting and social cognitive theories. Mowen et al. found that subjects performed more poorly with hard goals than medium goals under a bonus pay system, the opposite of what was found for a piece-rate system. In the present study, an hourly pay condition was added. Mowen et al.'s interaction was replicated using a two-trial design in which subjects could obtain feedback about their ability to attain the incentive bonuses between trials. The experimental effects were completely mediated by personal goals and self-efficacy. Goal commitment was related to performance, but did not mediate the experimental conditions. The implications for the design of incentive systems are discussed.

The impact of uncertainty and monitoring by the board of directors on incentive system design

Executive compensation and incentive packages have received a great deal of attention recently in the professional business literature as well as from the accounting standard setters. Examines the design of compensation systems. Suggests that environmental uncertainty and monitoring by the board of directors are both negatively related to the use of outcomebased compensation systems and that additionally, since this topic has both management accounting as well as financial accounting implications, it may provide a more comprehensive framework for investigating control system designs.

An incentive to shirk, privately held information, and managers' project evaluation decisions

A significant body of research indicates that managers often continue projects which logically should be discontinued to prevent subsequent losses to their firms. Affective explanations are usually provided for these apparently illogical decisions; for example, feelings of personal responsibility may bias the managers' evaluation of a project. In contrast, this study employs two agency theory concepts to investigate whether a rational explanation may exist for these decisions. A decision-making experiment was performed to examine the prediction that project managers who both experienced an incentive to shirk and possessed privately held information would exhibit a greater tendency to continue a project which was expected to become unprofitable than would those who experienced only one or neither of these conditions. Consistent with agency theory, the results indicate these two factors interact, providing support for the predicted relationships. Implications for the design of management incentive and control systems and suggestions for further research are presented.

Cultural influences on the design of incentive systems: The case of East Asia

Arguing that culture moderates the potency of various incentives in motivating employees, we propose a culture-contingent model of incentive system design in this article. Four nation-level determinants of culture are identified: historical events, economic/political structure, geographical location, and language characteristics. Based on evidence found in East Asia, specific propositions that either relate a national characteristic to some cultural attributes or predict how a cultural characteristic favours a particular type of incentive system are generated. The implications of this culture-contingent model for incentive system design in multinational firms are discussed.

An Empirical Investigation of the Relative Performance Evaluation Hypothesis

The principal-agent framework has become a widely used paradigm in accounting and economics for analyzing issues in performance evaluation, management control, and the design of incentive systems. While recent work in experimental economics has begun to examine empirically some of the underlying assumptions and implications of agency theory (see Baiman and Lewis [1989] and Kirby [forthcoming]), few precise hypotheses have been tested using real-world or naturally-occurring data. One exception has been the empirical investigation of the relative performance evaluation (RPE) hypothesis. Agency theory suggests that there are benefits associated with evaluating agents on the basis of their relative performances when the agents' performances are affected by a common term (e.g., see Diamond and Verrecchia [1982] and Holmstrom [1979; 1982]). Specifically, a relative performance-based contract can remove the common shock term from an agent's performance, which enables a better evaluation of the agent's actions.

Accounting for accounting: A story about managerial accounting

‘Accounting’, as the term is utilized in textbooks, discussed by teachers and researchers, and practiced by accountants, has evolved a narrow and specific meaning. It refers to the financial transactions of enterprises, and is generally concerned with the process of codifying, summarizing and reporting on such transactions. Although recent years have seen (at least on the research front) accounting becoming more broadly defined to include such things as individual and group reactions to transactions or their results (see, e.g. the human information processing research conducted by Ashton, 1976, and others, and the efficient market research undertaken by Beaver, 1972, and others), other interpretations and analyses based on the term itself have not occurred. For example, a recent article by Silverman (1975) on accounting in organizations bears little or no resemblance to “our” sort of accounting. What Silverman is concerned with are accounts as stories, the tales individual members of organizations construct to explain, understand and justify the behavior of themselves and others in organizations. Just such interpretation and analysis provided the genesis of the arguments in the present paper which attempt to explain what management accounting is and, more importantly, why it exists. Prior to launching into this explanation, a short digression on another recent approach which addresses these same questions sets the stage for the ensuing analysis. The newest explanation for the what and why of managerial accounting that has appeared in the literature is agency theory. In simple form, the argument is advanced that a principal (or owner) will seek accounting reports from an agent (or manager) as a form of control in an attempt to ensure that his resources are not being squandered. A number of papers have appeared based on this relatively simple proposition, for example Zimmerman’s (1979) research on cost allocation, Demski & Feltham (1978) on budgeting and Atkinson (1979) on standard setting problems. The work has basically been concerned with the design of incentive and accounting systems to overcome the assumed fundamental incentive of an agent to provide a less than honest report on his utilization of assets. Importantly, as Zimmerman (1979) argues, the questions are addressed in a positive rather than normative form. The fundamental difficulty with what amounts to an agency theory of the firm is that unidimensional explanations of behavior are, in general, not rich enough to capture the variety of human experience. Central to agency notions are assumptions that agents as resourceful, evaluative, maximizing men (REMMS) will, in the absence of tight restraints and controls engage in activities such as shirking, theft and on-the-job leisure, or the consumption of prerequisites such as “. . . thick carpets, air-conditioning or congenial employees” (Zimmerman, 1979, p. 506). The behavioral assumptions of REM men must be severely questioned in the light of the last twenty years of research into the area of human choice (March, 1978); the elements of Taylorism in the description of expected behaviors is an overly simplistic and inaccurate model of behavior in organizational settings. For example, the role of power in

Effort, Uncertainty, and the New Soviet Incentive System

Intractable problems apparently plague the design of efficacious incentive systems in hierarchical organizations as diverse as multi-divisional firms and centrally planned economies. The classic USSR incentive system failed to encourage subordinates to (1) convey accurate information about their expected performance to their superiors and (2) operate at their maximum capabilities. Enterprise managers received no bonus if the output plan were underfulfilled, were paid a substantial bonus when the plan was fulfilled, and received additional bonuses for overfulfillment. Consequently, managers had an incentive to seek an output target less than the output they were capable of producing. In addition, the ratchet principle (where superiors base next period's target on this period's results) caused managers to operate their enterprises at less than full capacity. Maximizing output this period increases next period's target and thereby decreases the probability of earning next period's bonus for fulfilling the plan. Soviet administrators were aware of these attempts to seek low targets and to conceal capacity and responded by imposing targets higher than those desired by managers. Since these administrators possess imperfect information, they sometimes imposed infeasible targets on enterprise managers. Inaccurately set targets and low rates of capacity utilization both waste resources. In particular, inaccurate targets impair the ability of the center to

Employee reactions to a pay incentive plan.

The reaction of a work group to a pay incentive plan is studied. An analysis of the employees’ attitudes reveals that they trust management, understand the plan, and see a close relationship between their pay and their performance. Based upon expectancy theory, it is hypothesised that because these conditions exist, the workers will respond directly to the economic payoff structure of the plan. In order to test this hypothesis, a mathematical model is developed to predict the productivity of the work group. The data show a high degree of fit between the model’s predictions and the actual productivity of the group. The implications of this for future research and for the design of incentive systems are discussed.