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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.

Suggested Citation

  • Ederer, Florian & Manso, Gustavo, 2009. "Is Pay-For-Performance Detrimental to Innovation?," Department of Economics, Working Paper Series qt03t787q9, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
    • Handle: RePEc:cdl:econwp:qt03t787q9
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    Cited by:

    1. Thomas Astebro & Holger Herz & Ramana Nanda & Roberto A. Weber, 2014. "Seeking the Roots of Entrepreneurship: Insights from Behavioral Economics," Journal of Economic Perspectives, American Economic Association, vol. 28(3), pages 49-70, Summer.
    2. Balsmeier, Benjamin & Buchwald, Achim & Stiebale, Joel, 2014. "Outside directors on the board and innovative firm performance," Research Policy, Elsevier, vol. 43(10), pages 1800-1815.
    3. Michael Gibbs & Susanne Neckermann & Christoph Siemroth, 2017. "A Field Experiment in Motivating Employee Ideas," The Review of Economics and Statistics, MIT Press, vol. 99(4), pages 577-590, July.
    4. Jed De Varo & Suraj Prasad, 2015. "The Relationship between Delegation and Incentives Across Occupations: Evidence and Theory," Journal of Industrial Economics, Wiley Blackwell, vol. 63(2), pages 279-312, June.
    5. Lucia Marchegiani & Tommaso Reggiani & Matteo Rizzolli, 2013. "Severity vs. Leniency Bias in Performance Appraisal: Experimental evidence," BEMPS - Bozen Economics & Management Paper Series BEMPS01, Faculty of Economics and Management at the Free University of Bozen.
    6. 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.
    7. Joy Buchanan & Bart Wilson, 2014. "An experiment on protecting intellectual property," Experimental Economics, Springer;Economic Science Association, vol. 17(4), pages 691-716, December.
    8. Zhaocheng Xu & Jingchuan Hou, 2024. "CEO overseas experience, dynamic capabilities and corporate digital transformation: An imprinting theory perspective," Humanities and Social Sciences Communications, Palgrave Macmillan, vol. 11(1), pages 1-14, December.
    9. Brüggemann, Julia & Crosetto, Paolo & Meub, Lukas & Bizer, Kilian, 2016. "Intellectual property rights hinder sequential innovation. Experimental evidence," Research Policy, Elsevier, vol. 45(10), pages 2054-2068.
    10. Viral V. Acharya & Ramin P. Baghai & Krishnamurthy V. Subramanian, 2014. "Wrongful Discharge Laws and Innovation," The Review of Financial Studies, Society for Financial Studies, vol. 27(1), pages 301-346, January.
    11. Diego d'Andria, 2016. "Taxation and Incentives to Innovate: A Principal-Agent Approach," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 72(1), pages 96-123, March.
    12. Akhtar, Iram & Cheema, Khaliq Ur Rehman, 2013. "Evaluation of Principal Performance in Public and Private Sector Schools," MPRA Paper 53364, University Library of Munich, Germany, revised 2013.
    13. Claire Bonnard, 2011. "Les incitations à l'innovation dans le secteur privé," Post-Print halshs-00599700, HAL.
    14. Marchegiani, Lucia & Reggiani, Tommaso G. & Rizzolli, Matteo, 2011. "How Unjust! An Experimental Investigation of Supervisors' Evaluation Errors and Agents' Incentives," IZA Discussion Papers 6254, Institute of Labor Economics (IZA).
    15. Sourav Bhattacharya & Pavel Chakraborty & Chirantan Chatterjee, 2018. "Intellectual Property Regimes and Firm Structure," Working Papers 240829812, Lancaster University Management School, Economics Department.

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