Social Econ Blog

Tough work for the fruit-pickers, the business is also a headache for the owner, who must offer a pay scheme that both satisfies minimum-wage laws and motivates workers in an industry in which slacking is an understandable temptation. The owner of a large British fruit-farm business, "Farmer Smith," was pondering the problem one Christmas when he discovered that the connection between pay and performance was also an area where economists were scratching around for solid evidence.

And so an unlikely alliance was formed between Farmer Smith and economists Oriana Bandiera, Iwan Barankay, and Imran Rasul. The economists would design and administer pay schemes, and in exchange for that (and for confidentiality), Farmer Smith would let them treat his business as a gigantic laboratory for researching the nexus between pay, workplace friendships (which they mapped out), and workers' productivity.

The owner had been paying a piece rate—a rate per kilogram of fruit—but also needed to ensure that whether pickers spent the day on a bountiful field or a sparse one, their wages didn't fall below the legal hourly minimum. Farmer Smith tried to adjust the piece rate each day so that it was always adequate but never generous: The more the work force picked, the lower the piece rate. But his workers were outwitting him by keeping an eye on each other, making sure nobody picked too quickly, and thus collectively slowing down and cranking up the piece rate.

Bandiera and her colleagues proposed a different way of adjusting the piece rate: Managers would test-pick the field to see how difficult it was and set the rate accordingly, thus preventing the workers from engaging in a collective go-slow. (If the managers made a mistake in their estimate, and the pickers didn't earn minimum wage, Farmer Smith would make up the shortfall with an extra payment. This rarely happened.) The economists measured the result. By the time the experiment was over, Farmer Smith's initial skepticism had long evaporated: The new pay scheme increased productivity (kilograms of fruit per worker per hour) by about 50 percent.

BY withholding bonuses from their top executives, Goldman Sachs and UBS may soften negative reaction from Congress and the public if their earnings reports in December are poor, as is expected. But will they also suffer because their executives, lacking the motivation that big bonuses are thought to provide, will not do their jobs well?

Of course, there are many reasons to be disgusted with executive pay. It feels unfair that so many people make so much money managing our money, and it is often difficult to see how their talent and abilities justify their compensation. We find it particularly offensive when executives receive high bonuses after disastrous performances. But doesn’t the promise of a big bonus push people to work to the best of their ability?

To look at this question, three colleagues and I conducted an experiment. We presented 87 participants with an array of tasks that demanded attention, memory, concentration and creativity. We asked them, for instance, to fit pieces of metal puzzle into a plastic frame, to play a memory game that required them to reproduce a string of numbers and to throw tennis balls at a target. We promised them payment if they performed the tasks exceptionally well. About a third of the subjects were told they’d be given a small bonus, another third were promised a medium-level bonus, and the last third could earn a high bonus.

We did this study in India, where the cost of living is relatively low so that we could pay people amounts that were substantial to them but still within our research budget. The lowest bonus was 50 cents — equivalent to what participants could receive for a day’s work in rural India. The middle-level bonus was $5, or about two weeks’ pay, and the highest bonus was $50, five months’ pay.

What would you expect the results to be? When we posed this question to a group of business students, they said they expected performance to improve with the amount of the reward. But this was not what we found. The people offered medium bonuses performed no better, or worse, than those offered low bonuses. But what was most interesting was that the group offered the biggest bonus did worse than the other two groups across all the tasks.

This blog post and article, draw attention to the fact that bonuses are often imperfectly aligned with the principals' true interests. Sometimes this is just poor incentive design, sometimes it is simply because the only observable outcomes don't exactly capture the principal's interests:

On this afternoon's All Things Considered, NPR correspondent Scott Horsley uses Michael Lewis' February piece on Shane Battier in the New York Times as a springboard to discuss how compensation on Wall Street rewards bankers and traders for the wrong reasons:

The point of Lewis's article is that those individual stats, while easy to measure and reward, are not what is really important. In fact, if a player's bonuses are tied too closely to individual stats, they can actually end up rewarding actions that hurt the team in the long run.

To University of San Diego law professor Frank Partnoy, that sounds a lot like Wall Street.

"I think there are a lot of parallels between the NBA and the MBA," Partnoy says. "These are markets where the superstars are going to take home the highest compensation and they are going to feel like they are worth it."

Partnoy says just like a ballplayer who gambles on a bad shot instead of passing to an open teammate, Wall Street bankers face a constant temptation to pad their own stats, and bonuses, even at the expense of their team.

"Maybe juice up their returns for a year, take on excess risks for a year, make that big bonus over the short term, and have their team suffer or their bank suffer in the long term," he says ...

... The long-term viability of banks is pretty important. Selfish basketball players can cost their team a shot at the playoffs. Bankers who play for themselves can put the whole economy at risk.

// posted by BW @ 10:07 AM