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The Welfare Effects of Incentive Schemes

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Author Info
ADAM COPELAND
CYRIL MONNET

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Abstract

This paper computes the change in welfare associated with the introduction of incentives. We calculate by how much the welfare gains of increased output due to incentives outweigh workers' disutility from increased effort. We accomplish this by studying the use of incentives by a firm in the check-clearing industry. Using this firm's production records, we model and estimate the worker's dynamic effort decision problem. We find that the firm's incentive scheme has a large effect on productivity, raising it by 12% over the sample period for the average worker. Using our parameter estimates, we show that the cost of increased effort due to incentives is equal to the dollar value of a 5% rise in productivity. Welfare is measured as the output produced minus the cost of effort; hence, the net increase in the average worker's welfare due to the introduction of the firm's bonus plan is 7%. Under a first-best scheme, we find that the net increase in welfare is 9%. Copyright © 2009 The Review of Economic Studies Limited.

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File URL: http://www.blackwell-synergy.com/doi/abs/10.1111/j.1467-937X.2008.00513.x
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Article provided by Blackwell Publishing in its journal Review of Economic Studies.

Volume (Year): 76 (2009)
Issue (Month): 1 (01)
Pages: 93-113
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Handle: RePEc:bla:restud:v:76:y:2009:i:1:p:93-113

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  7. Chevalier, Judith & Ellison, Glenn, 1997. "Risk Taking by Mutual Funds as a Response to Incentives," Journal of Political Economy, University of Chicago Press, vol. 105(6), pages 1167-1200, December.
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  8. Pakes, Ariel S, 1986. "Patents as Options: Some Estimates of the Value of Holding European Patent Stocks," Econometrica, Econometric Society, vol. 54(4), pages 755-84, July. [Downloadable!] (restricted)
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  10. Grossman, Sanford J & Hart, Oliver D, 1983. "An Analysis of the Principal-Agent Problem," Econometrica, Econometric Society, vol. 51(1), pages 7-45, January. [Downloadable!] (restricted)
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  11. Canice Prendergast, 1999. "The Provision of Incentives in Firms," Journal of Economic Literature, American Economic Association, vol. 37(1), pages 7-63, March. [Downloadable!] (restricted)
  12. Margiotta, Mary M & Miller, Robert A, 2000. "Managerial Compensation and the Cost of Moral Hazard," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 41(3), pages 669-719, August.
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  1. Steinar StrØm & John K. Dagsvik, 2006. "Sectoral labour supply, choice restrictions and functional form," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 21(6), pages 803-826. [Downloadable!]
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