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The Impact of Risk Aversion and Stress on the Incentive Effect of Performance Pay

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Author Info

  • C. Bram Cadsby

    ()
    (Department of Economics, University of Guelph)

  • Fei Song

    ()
    (Ted Rogers School of Business Management, Ryerson University)

  • Francis Tapon

    ()
    (Department of Economics, University of Guelph)

Abstract

We demonstrate that effectiveness of performance-contingent incentives is inversely related to individual risk-aversion levels through two mechanisms: 1) rational optimizing decisions about the amount of effort to supply when effort is positively correlated with risk exposure and 2) the possibly choke-inducing stress accompanying financial uncertainty. In two laboratory studies using real-effort tasks, we find a significant inverse relationship between productivity improvement under performance pay and risk-aversion levels. Moreover, we show that both mechanisms help explain this result. For about 25% of participants, performance actually deteriorates under performance pay, and the probability of such deterioration increases with risk aversion and stress.

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Bibliographic Info

Paper provided by University of Guelph, Department of Economics and Finance in its series Working Papers with number 0912.

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Length: 38 pages
Date of creation: 2009
Date of revision:
Handle: RePEc:gue:guelph:2009-12

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Related research

Keywords: risk aversion; performance pay; incentive; stress; choking under pressure; productivity; pay for performance; piece rate; experiment; compensation.;

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Cited by:
  1. Marco A. Marini & Paolo Polidori & Desiree Teobaldelli & Davide Ticchi, 2014. "Optimal Incentives in a Principal-Agent Model with Endogenous Technology," DIAG Technical Reports 2014-01, Department of Computer, Control and Management Engineering, Universita' degli Studi di Roma "La Sapienza".
  2. Zubanov, N.V., 2012. "Risk Aversion and Effort in an Incentive Pay Scheme with Multiplicative Noise: Theory and Experimental Evidence," ERIM Report Series Research in Management ERS-2012-005-STR, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus Uni.

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