2. Bahaviorial incentives
1. Behaviorial incentives (slides1, slides2, slides3, ProblemSet1, ProblemSet2)
 Setting the scene: Explain the difference between explicit, implicit incentives
and behavioral incentives and give examples for each of them.
 Main focus: Outline how concerns for fairness work as a motivator.
 Discuss work policies that foster vs. crowd-out intrinsic motivation or motivation
through fairness concerns.
Introduction:
Many people work in a firm where they provide effort and make decisions. A fundamental
challenge in designing firms, is to create goal alignment between the shareholders and the
employees. But why do we often see employees receiving only fixed wages? This is because
people face implicit incentives and behavioral incentives.
I would like to introduce behavioral incentives focusing on how concerns for fairness works
as a motivator. In the end, I will discuss how intrinsic motivators are crowded out
Setting the scene:
Explicit vs implicit vs behavioral
- Explicit incentives are monetary incentives that are tied to the performance of the
employee. Objective performance measures.
- Implicit incentives are the one arising owing to the existence of non-observable and
non-verifiable aspects. Subjective performance measures.
- Behavioral incentives: Incentives such as intrinsic motivation, fairness concerns and
non-monetary rewards
The existence of non-monetary incentives can be used to explain why employees receiving
fixed wages are working hard and providing higher than ‘minimum’ effort…
Explicit incentives:
-
Bonus payments for achieving curtain revenue targets.
Free parking
Sales commission
Stock options
Implicit incentives:
1. Subjective performance evaluations: The employees are rewarded in a discretionary
way. E.g., reviews from supervisor and co-workers or a merit-based rating system.
2. Promotion tournaments: Employees compete for promotion based on relative
evaluations to get promoted to higher and better paid levels.
3. Threat of Termination (efficiency wages theory): The threat of being fired can
work as an implicit incentive. Efficiency wage creates more implicit incentives to
work harder to avoid being fired.
4. Career concerns: When a person has concerns for future career, which affects his or
her incentives to work hard today e.g., final grade.
 Career concerns are stronger, when the employee is longer from retirement
Behavioral incentives.
Intrinsic motivation: Motivation coming from the inside – driven by emotional aspects of
the work. Employees are often willing to exert costly effort for reasons other than explicit
material incentives. For example, priests, teachers, maybe doctors.
 Explicit rewards often crowd out the intrinsic motivation. Psychologist found out, that
some chose to work less if they were explicitly rewarded.
Fairness concerns:
Main focus: Outline how concerns for fairness work as a motivator.
Why don’t companies cut wages during recessions. We know from implicit incentives, that the
more likely you are to being fired, the lower wage you are willing to accept. Part of the
explanation lies in “fairness concerns”
Another behavioral incentive that induces higher effort is “concerns of fairness, which is a
non-financial motivation that motivates employees to be more productive and innovative.
A model of gift exchange (Akerlof):
… Employees respond to generous treatments from the firm by exerting above minimal effort.
Manager offers wage 𝑤 to employee. The employee can either accept or reject 𝑤.
- Rejection, both parties receive 0.
- Acceptance: The employee has to make a costly effort choice 𝑒.
Payoffs of acceptance:
Predictions:
1. The efficient effort level (maximizes 𝑆𝑆 = 𝑅 − 𝐶):
2. The actual effort level:
Conclusion: The employee maximizes payoff by providing the lowest effort level 𝑒 = 0.
BUT this isn’t what’s observed in the real world:
- Positive wage-effort relationship: Employees repay the “gifts” by providing effort
above minimum effort level → reciprocal.
- Some employees shirk as predicted in the standard model – but some work harder
owing to the gift exchanges and FAIRNESS CONCERNS!
Illustration of inequity aversion and fairness concerns:
- Individuals are inequity averse – the dislike being behind more than being ahead.
-
The employee chooses effort level to equalize material payoff between principal and
himself, due to fairness concerns:
The manager anticipates this and maximizes own payoff under the equality-constraint:
Conclusion: "If people are fair, we actually receive an efficient outcome level."
- The inequity aversion acts as an incentive device because the agent responds to a
higher wage by increasing effort to eliminate any inequality.
- Knowing that the employee is inequity averse, the principal can “manipulate” the
effort levels provided by the employee, by having high effort himself
- Discuss work policies that foster vs. crowd-out intrinsic
motivation or motivation through fairness concerns.
Foster:
Patagonia:
If the employees have social preferences, and the company pays an amount of their profits to
charity. A good example is the fashion brand Patagonia. They donate 1% of their sales to
charities. This works as an incentivizer, because we expect employees with social preferences
will work harder if this directly leads to larger donations.
Monitoring:
Studies further shows, that when a company stops monitoring employees, their job
satisfaction will rise. When job satisfaction rise, there is a tendency for employees to work
harder. This seems so counter intuitive in the standard model because we observed, that when
there is asymmetric information, employees will provide a lower effort level.
Effort level measurement/ inequity averse
Companies could make some sort of measurement for employees to know each other’s payoff
levels, for them to align their effort levels, which will make them work harder as a unit than if
they did not know about each other’s effort levels.
Crowding out intrinsic motivators
We have seen experiments, where intrinsic motivation was crowded out by explicit
incentives. One strong example is the “fine for being late” in schools’ experiment.
- Two groups. One where there were fine for arriving late, and one control group.
- Showed that the “fine group” had substantial later arrivals.
- The intrinsic motivator is, that it is embarrassing to pick up your kids late.
Looking glass self:
When we observe a large explicit monetary incentive to do some task, we expect the task to
be hard and therefore we will avoid doing the task, even though we would do it in the
standard model
Crowding ou fairness concerns
- We know that the employee will provide an effort that makes the material output of
employee and manager equal if he is strongly inequal averse. But if we look at this
utility setup. But if there are strong
-
explicit monetary incentives for providing
high effort levels, the employee could
end up working much harder than the
manager, because the fairness concern
is crowded out.
(but is it that bad, that the employee
provides more effort than the manager?,
possibly not.