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Is Pay-For-Performance Detrimental to Innovation?

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  • Ederer, Florian
  • Manso, Gustavo

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.

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Bibliographic Info

Paper provided by Department of Economics, Institute for Business and Economic Research, UC Berkeley in its series Department of Economics, Working Paper Series with number qt03t787q9.

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Date of creation: 04 Aug 2009
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Handle: RePEc:cdl:econwp:qt03t787q9

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  1. Sillamaa, M. A., 1999. "How work effort responds to wage taxation: An experimental test of a zero top marginal tax rate," Journal of Public Economics, Elsevier, vol. 73(1), pages 125-134, July.
  2. Yuliy Sannikov, 2008. "A Continuous-Time Version of the Principal-Agent Problem," Review of Economic Studies, Wiley Blackwell, vol. 75(3), pages 957-984, 07.
  3. Weitzman, Martin L, 1979. "Optimal Search for the Best Alternative," Econometrica, Econometric Society, vol. 47(3), pages 641-54, May.
  4. Nalbantian, Haig R & Schotter, Andrew, 1997. "Productivity under Group Incentives: An Experimental Study," American Economic Review, American Economic Association, vol. 87(3), pages 314-41, June.
  5. Rogerson, William P, 1985. "Repeated Moral Hazard," Econometrica, Econometric Society, vol. 53(1), pages 69-76, January.
  6. Bruce Shearer, 2004. "Piece Rates, Fixed Wages and Incentives: Evidence from a Field Experiment," Review of Economic Studies, Wiley Blackwell, vol. 71(2), pages 513-534, 04.
  7. Robert J. Meyer & Yong Shi, 1995. "Sequential Choice Under Ambiguity: Intuitive Solutions to the Armed-Bandit Problem," Management Science, INFORMS, vol. 41(5), pages 817-834, May.
  8. Yuliy Sannikov, 2008. "A Continuous-Time Version of the Principal-Agent Problem," Review of Economic Studies, Oxford University Press, vol. 75(3), pages 957-984.
  9. Merlo, A. & Schotter, A., 1995. "A Surprise-Quiz View of Learning in Economic Experiments," Working Papers 95-32, C.V. Starr Center for Applied Economics, New York University.
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Cited by:
  1. Oliver Baumann & Nils Stieglitz, 2011. "Motivating Organizational Search," DRUID Working Papers 11-08, DRUID, Copenhagen Business School, Department of Industrial Economics and Strategy/Aalborg University, Department of Business Studies.
  2. Claire Bonnard, 2011. "Les incitations à l'innovation dans le secteur privé," Post-Print halshs-00599700, HAL.

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