Experimental Evidence for Agency Models of Salesforce Compensation
Academic work on sales compensation plans features agency models prominently, and these models have also been used to build decision aids for managers. However, empirical support remains sketchy. We conducted three experiments to investigate three unresolved predictions involving the incentive-insurance trade-off posited in the model. First, compensation should be less incentive loaded with greater effort-output uncertainty so as to provide additional insurance to a risk-averse agent. Second, flat wages should be used for verifiable effort so as to avoid unnecessary incentives. Third, less incentive-loaded plans should be used with more risk-averse agents so as to provide additional insurance. Our design implemented explicit solutions from a specific agency model, which offers greater internal validity, compared to extant laboratory designs that either did not implement explicit solutions or excluded certain parameters. In Experiment I, data from working manager subjects supported the first prediction but only when risk-averse agents undertook nonverifiable effort. We interpret this as disclosing the model's “core” circumstance, wherein it orders the data when the incentive-insurance trade-off is relevant. Thus, when verifiable effort made incentives moot, as is the case for the second prediction, the model failed to order the data. Building on these results, we reasoned that the third prediction should find support among risk-averse agents but not among risk-neutral agents, because insurance is a moot point with the latter agents. To this end, we added risk-neutral utility functions for agents in Experiment II. Data from MBA-candidate student subjects supported the predictions, but only when risk-averse agents undertook nonverifiable effort. In those cells in which the incentive-insurance trade-off was moot (either because of risk-neutrality or else verifiability), the data did not support the predictions. We confronted several validity threats to these results. To begin, Experiment I used the standard agency solution, which equalizes an agent's expected utility from the predicted plan with his expected utility from rejecting it. Subjects might have broken these ties on such grounds as fairness. To assess whether this confounded the results, we derived new solutions in Experiment II that broke ties in favor of the predicted plan (by a 10% margin in the expected utility). Our results were robust to this change. Second, our agents' behavior in Experiments I and II was much more consistent with predictions, compared to the principals' behavior, which broughtup task comprehension as a validity threat because our principals faced a more complex experimental task than the agents. To address this threat, we used three decision rounds in Experiment III to reduce the principals' task comprehension problems. A related validity threat arose from the relatively small gap in some cells between a principal's predicted expected utility and the principal's next best choice. To address this threat, we derived new solutions with larger gaps to make the principal's choices “easier.” The results were again robust to these changes, which removes these validity threats. We also addressed two alternative explanations. Might principals be predisposed to pick salary plus commission plans regardless of the model's predictions? If so, we should find such plans chosen uniformly across different experimental conditions. Pooling the data from our three experiments, we rejected this predisposition explanation by finding variation that was more consistent with treatment differences across cells. Second, mightagents choose higher effort levels because of a demand bias? If so, we should find agents picking high effort regardless of the plan actually offered to them. Using pooled data, we rejected this explanation by finding variation that was more consistent with a utility-maximizing reaction to the plan actually offered to them. Finally, we included manipulation checks to assess whether principals and agents perceived experimental stimuli identically, as per the “common knowledge” assumption in game theory. These data showed no differences between agents' and principals' perceptions of stimuli. Our experiments move the literature from simply asking whether the model works to pinpointing the circumstances in which itorders behavior. The primary stylized fact we uncovered is the persistent and striking lack of support for the agency model outside of the circumstance in which riskaverse agents undertake nonverifiable effort. The model's failure when there is no material insurance-incentive tradeoff deserves scrutiny in future work.
Volume (Year): 19 (2000)
Issue (Month): 4 (August)
|Contact details of provider:|| Postal: 7240 Parkway Drive, Suite 300, Hanover, MD 21076 USA|
Web page: http://www.informs.org/
More information through EDIRC
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Grossman, Sanford J & Hart, Oliver, 1985.
"The Cost and Benefits of Ownership: A Theory of Vertical and Lateral Integration,"
CEPR Discussion Papers
70, C.E.P.R. Discussion Papers.
- Grossman, Sanford J & Hart, Oliver D, 1986. "The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration," Journal of Political Economy, University of Chicago Press, vol. 94(4), pages 691-719, August.
- Grossman, Sanford J. & Hart, Oliver D., 1986. "The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration," Scholarly Articles 3450060, Harvard University Department of Economics.
- Oliver Hart & Sanford Grossman, 1985. "The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration," Working papers 372, Massachusetts Institute of Technology (MIT), Department of Economics.
- Bengt Holmstrom, 1979.
"Moral Hazard and Observability,"
Bell Journal of Economics,
The RAND Corporation, vol. 10(1), pages 74-91, Spring.
- Forsythe Robert & Horowitz Joel L. & Savin N. E. & Sefton Martin, 1994. "Fairness in Simple Bargaining Experiments," Games and Economic Behavior, Elsevier, vol. 6(3), pages 347-369, May.
- Shantanu Dutta & Mark Bergen & George John, 1994. "The Governance of Exclusive Territories When Dealers can Bootleg," Marketing Science, INFORMS, vol. 13(1), pages 83-99.
- Joyce E. Berg & Lane A. Daley & John W. Dickhaut & John R. O'Brien, 1986. "Controlling Preferences for Lotteries on Units of Experimental Exchange," The Quarterly Journal of Economics, Oxford University Press, vol. 101(2), pages 281-306.
- Simonson, Itamar, 1989. " Choice Based on Reasons: The Case of Attraction and Compromise Effects," Journal of Consumer Research, Oxford University Press, vol. 16(2), pages 158-174, September.
- Coughlan, Anne T & Narasimhan, Chakravarthi, 1992. "An Empirical Analysis of Sales-Force Compensation Plans," The Journal of Business, University of Chicago Press, vol. 65(1), pages 93-121, January.
- Narayan S. Umanath & Manash R. Ray & Terry L. Campbell, 1996. "The Effect of Uncertainty and Information Asymmetry on the Structure of Compensation Contracts: A Test of Competing Models," Management Science, INFORMS, vol. 42(6), pages 868-874, June.
- V. Padmanabhan & Ram C. Rao, 1993. "Warranty Policy and Extended Service Contracts: Theory and an Application to Automobiles," Marketing Science, INFORMS, vol. 12(3), pages 230-247.
- Vesna Prasnikar, 1993. "Binary Lottery Payoffs: Do They Control Risk Aversion?," Discussion Papers 1059, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
- Rajiv Lal & Richard Staelin, 1986. "Salesforce Compensation Plans in Environments with Asymmetric Information," Marketing Science, INFORMS, vol. 5(3), pages 179-198.
- Narayan S. Umanath & Manash R. Ray & Terry L. Campbell, 1993. "The Impact of Perceived Environmental Uncertainty and Perceived Agent Effectiveness on the Composition of Compensation Contracts," Management Science, INFORMS, vol. 39(1), pages 32-45, January.
- Rietz, Thomas A, 1993. "Implementing and Testing Risk-Preference-Induction Mechanisms in Experimental Sealed-Bid Auctions," Journal of Risk and Uncertainty, Springer, vol. 7(2), pages 199-213, October.
When requesting a correction, please mention this item's handle: RePEc:inm:ormksc:v:19:y:2000:i:4:p:348-365. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Mirko Janc)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.