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Low-powered incentives

  • Joseph A. Ritter
  • Lowell J. Taylor

We study low-powered incentives in a model that captures important features of workplaces in which incentive-pay approaches are minimally relevant. Our motivation is that incentive pay, while not rare, is clearly far less common than are agency problems: many firms with agency problems nonetheless pay fixed compensation and offer continued employment to all but those workers judged "unsatisfactory" according to largely subjective criteria. We find that low-powered incentives can achieve efficient outcomes in simple workplaces and function surprisingly well even when the environment is characterized by unobservable performance heterogeneity and a high degree of complementarity among workers.

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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 1999-005.

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Date of creation: 1999
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Handle: RePEc:fip:fedlwp:1999-005
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  1. Paul R. Milgrom, 1979. "Good Nevs and Bad News: Representation Theorems and Applications," Discussion Papers 407R, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  2. Edward P. Lazear & Sherwin Rosen, 1979. "Rank-Order Tournaments as Optimum Labor Contracts," NBER Working Papers 0401, National Bureau of Economic Research, Inc.
  3. Kremer, Michael, 1993. "The O-Ring Theory of Economic Development," The Quarterly Journal of Economics, MIT Press, vol. 108(3), pages 551-75, August.
  4. Kremer, M & Maskin, E, 1996. "Wage Inequality and Segregation by Skill," Working papers 96-23, Massachusetts Institute of Technology (MIT), Department of Economics.
  5. Baker, George & Gibbons, Robert & Murphy, Kevin J, 1994. "Subjective Performance Measures in Optimal Incentive Contracts," The Quarterly Journal of Economics, MIT Press, vol. 109(4), pages 1125-56, November.
  6. W. Bentley MacLeod & Daniel Parent, 1998. "Job Characteristics and the Form of Compensation," CIRANO Working Papers 98s-08, CIRANO.
  7. Lazear, Edward P, 1989. "Pay Equality and Industrial Politics," Journal of Political Economy, University of Chicago Press, vol. 97(3), pages 561-80, June.
  8. Prendergast, Canice & Topel, Robert H, 1996. "Favoritism in Organizations," Journal of Political Economy, University of Chicago Press, vol. 104(5), pages 958-78, October.
  9. Michael Kremer & Eric Maskin, 1996. "Wage Inequality and Segregation," Harvard Institute of Economic Research Working Papers 1777, Harvard - Institute of Economic Research.
  10. Malcomson, James M, 1984. "Work Incentives, Hierarchy, and Internal Labor Markets," Journal of Political Economy, University of Chicago Press, vol. 92(3), pages 486-507, June.
  11. Canice Prendergast, 1999. "The Provision of Incentives in Firms," Journal of Economic Literature, American Economic Association, vol. 37(1), pages 7-63, March.
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