Using real-effort laboratory experiments with salient incentives, we examine the impact of pay-for-performance (PFP) versus fixed-salary (FS) compensation on productivity. PFP achieved significantly higher productivity through both sorting and incentive effects. In particular, more productive employees selected PFP, and employees on average, regardless of their preferred compensation scheme, produced more under PFP. Risk preferences were also important. Less risk-averse individuals were both more likely to select PFP and also more responsive to PFP incentives.
We compare, through a laboratory experiment using salient financial incentives, misrepresentations of performance under target-based compensation with those under both a linear piece-rate and a tournament-based bonus system. An anagram game was employed as the experimental task. Results show that productivity was similar and statistically indistinguishable under the three schemes. In contrast, whether one considers the number of overclaimed words, the number of work/pay periods in which overclaims occur, or the number of participants making an overclaim at least once, target-based compensation produced significantly more cheating than either of the other two systems. While earlier research has compared cheating under target-based compensation with cheating under non-performance-based compensation, which offers no financial incentive to cheat, this is the first study that compares cheating under target-based schemes to cheating under other performance-based schemes. The results suggest that cheating as a response to incentives can be mitigated without giving up performance pay altogether.
The purpose of this paper is to study idiosyncratic responses to financial incentives. We argue that the effectiveness of performance-contingent incentives on improving performance is inversely related to individual levels of risk aversion. We propose two mechanisms through which risk aversion affects the response to performance pay: 1) rational decisions about the amount of effort to supply when effort is positively correlated with risk exposure and 2) the possibly chokeinducing stress accompanying financial uncertainty, especially for more risk-averse people. Two laboratory studies using real-effort tasks with salient financial incentives were carried out to test these hypotheses. We found a significant and inverse relationship between productivity improvement under incentives and the level of risk aversion. Furthermore, we found that individual levels of risk aversion are inversely related to effort and risk-exposure under performance pay, while stress related to risk attitudes partially explains the adverse effect of risk aversion on productivity improvement. Moreover, higher levels of both risk aversion and stress increase the probability that productivity will worsen under performance pay.Keywords: risk aversion, performance pay, incentive, stress, choking under pressure, productivity, pay for performance, piece rate, experiment, compensation.JEL Codes: C91, M52, J33.
Acknowledgements:We gratefully acknowledge funding from SSHRC grants #410-2007-1380. We are greatly indebted to J. Atsu Amegashie for many important and stimulating discussions and suggestions. We are also grateful to James Cox, Mike Hoy, Alex Maynard, Thanasis Stengos and seminar audiences at University of Tasmania and University of Sydney for many helpful suggestions and comments.
In this study of five developed markets we analyse the sizes of portfolios required for achieving most diversification benefits. Using daily data, we trace the year-to-year dynamic of these sizes between 1975 and 2011. We compute several widely-accepted measures of risk and use an extreme risk measure to account for black swan events. In addition to providing portfolio size recommendations for an average investor, we estimate confidence bands around central measures of risk and offer recommendations for attaining most diversification benefits 90 percent of the time instead of on average. We find that investors concerned with extreme risk can achieve diversification benefits with a relatively small number of stocks.
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