Is Pay for Performance Detrimental to Innovation?

Abstract

Previous research in economics shows that paying the agent based on performance induces the agent to exert more effort thereby enhancing productivity. On the other hand, research in psychology argues that performance-based financial incentives may inhibit creativity and innovation. In a controlled laboratory experiment, we provide evidence that the combination of tolerance for early failure and reward for long-term success is effective in motivating innovation. Subjects under such an incentive scheme explore more and are more likely to discover a novel business strategy than subjects under fixed-wage and standard pay-for-performance incentive schemes. We also find evidence that the threat of termination can undermine incentives for innovation, while golden parachutes can alleviate these innovation-reducing effects. Our results suggest that appropriately designed incentives are useful in motivating creativity and innovation.

Wrongful Discharge Laws and Innovation

“…30 The data encompass measures of establishment openings, firm startups, and job creation from new establishments. 31 In particular, the BDS database cov- This dataset is particularly suited for the empirical analysis of entrepreneurship since the age of an establishment is defined based on the age of the ultimate parent firm.…”

“…32 29 This empirical prediction is consistent with the Xerox view of entrepreneurial spawning highlighted by Gompers, Lerner and Scharfstein (2005), where entrepreneurial spawning from incumbent firms is high not because of any sort of inefficiency at these firms, but rather because these firms wisely choose to focus on their core business or "core competence." 30 The BDS data are drawn from the Longitudinal Business Database, which is a database of U.S. business establishments and firms. Most of the information on the BDS database discussed below is drawn from the BDS Technical Note, available at the U.S. Census website: http : //www.ces.census.gov/index.php/bds 31 An establishment is defined as a fixed physical location where economic activity occurs; a firm may consist of one or more such establishments.…”

Loss aversion and the quantity–quality tradeoff

“…A series of papers in economics have used existing data or field experiments to investigate the relative merits of flat rate versus piece rate incentive schemes in the workplace (Lazear, 2000;Paarsch and Shearer, 2000;Shearer, 2004;Copeland and Monnet, 2009;Helper et al, 2010;Ederer and Manso, 2013;Al-Ubaydli et al, 2015). 2 The above papers find a positive impact of piece rates on quantity of output, but the evidence is mixed for its impact on quality.…”

“…2 The above papers find a positive impact of piece rates on quantity of output, but the evidence is mixed for its impact on quality. 3 For instance, Al-Ubaydli et al (2015) find increases in quality, while Johnson et al (2015) and Ederer and Manso (2013) find decreases in quality from pay-for performance compensation. There is also a new literature on incentives and creativity, documenting that financial incentives have a mixed effect on different dimensions of creative work, including quantity and quality (Kachelmeier et al, 2008;Charness and Grieco, 2014;Laske and Schröder, 2015;Erat and Gneezy, 2016).…”

Taxation and Incentives to Innovate: A Principal-Agent Approach

“…Some econometric studies (Lerner and Wulf 2007, Sauermann and Cohen 2010, Francis et al 2011, Azoulay et al 2011 as well as laboratory experiments (Ederer and Manso 2013) supply evidence that providing the right monetary (and non-monetary) incentives to key employees to make them invest in innovation is an important challenge for R&D-intensive firms and industries. A patent box policy alone can foster aggregate innovation as long as external constraints faced by firms are the sole obstacle.…”