Keywords: Principal-agent theory, personnel economics
Abstract: This paper computes the change in welfare associated with the
introduction of incentives. Specifically, we calculate by how
much the welfare gains of increased output due to incentives
outweigh workers' disutility from increased effort. We accomplish
this by studying the use of incentives by a firm in the check-clearing
industry. Using this firm's production records, we model and
estimate the worker's dynamic effort decision problem. We
find that the firm's incentive scheme has a large effect
on productivity, raising it by 14% over the sample period.
Using our parameter estimates, we show that the cost of
increased effort due to incentives is equal to the dollar
value of a 9% rise in productivity. Welfare is measured as
the output produced minus the cost of effort, hence the
net increase in welfare due to the introduction of the
firm's bonus plan is 5%. Under a first-best scheme, we
find that the net increase in welfare is 6%.
Full paper (254 KB PDF)
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Last update: February 25, 2003