Teams and other reward systems

Transcription

1 Teams and other reward systems Why do firms exist in the first place? When should teams be used? How does peer pressure operate in a team? How should a team look like, which individuals should form a team? Personnel Economics 10 1

2 Team compensation When/why would a company use team compensation? Individual effort difficult to measure Motivate cooperation among workers Congruence of type of work and type of compensation: If teamwork is important, use team-related pay Ex: Basketball Personnel Economics 10 2

3 The free-rider problem When individuals work in teams, it is difficult to observe the output of individuals possibility: compensation by team But: individuals can hide behind others (free ride) Personnel Economics 10 3

4 The free-rider problem in public goods Everybody in team contributes to output, but each member gets only a share of the reward for own action Example: sharing the bill at a restaurant Ten people go to the restaurant and share the bill. Do you order the cheap (10 ) or expensive menue (20 )? Why? What is the result? Personnel Economics 10 4

5 Everyday economics Lesson for staying slim? Go out in small groups and Never share the bill! Personnel Economics 10 5

6 Public goods problem in more detail There are two individuals i and j with 10 each. The money can be invested into a public good (x) or be kept for oneself. The payoff of individual i is given by: (10 x i ) (x i + x j ) How much would you put into the public good? Assume there is only the choice of putting all or nothing into the public good. How does the payoff-matrix look like? What is the result? Personnel Economics 10 6

7 Public goods problem Ten people are one team. Group gets a bonus of 100 if project is finished one day earlier. Bonus will be divided by number of group members. If you worked overtime one evening - instead of going out with your friends - you could speed up the project enough, so that it would be finished earlier. Will you stay late? Personnel Economics 10 7

8 Result of public goods problem One-shot prisoner s dilemma Efficient solution: everybody contributes everything to the public good Nash-solution: nobody contributes anything Remember from Managerial Economics or IO: In finitely repeated games: No cooperation Only infinite repetition of game or uncertainty about the end of game leads to cooperation Else: non-economic reasons like trust, norms, etc... See later Personnel Economics 10 8

9 WHEN TO USE TEAMS Personnel Economics 10 9

10 When to use teams? Benefits: Output of two (or more) workers together is more than the sum of the outputs of each worker Use teams if the whole is bigger than sum of its parts Large complementarities what one worker does and what another does Deadlines to meet Physical complementarities (lifting an object) Share information and coordinate better Costs: productivity loss through free-riding affected by size of team Personnel Economics 10 10

11 When to use teams? Benefits: Output of two (or more) workers together is more than the sum of the outputs of each worker Use teams if the whole is bigger than sum of its parts Example: 2 projects, each can be done by one worker in 4 weeks or two workers in 2 weeks. Project A gives profit of if finished in 4 weeks, if finished in 2 weeks. Project B has to be finished in 4 weeks, gives profit of Personnel Economics 10 11

12 Other direct benefits of team work Specialization Allows to do job more efficiently (Adam Smith) Knowledge transfer (if specialization is not too great) 1. Individuals possess non-overlapping (idiosyncratic) information sets 2. Idiosyncratic information possessed by one person is valuable to others team should consist of people who have something to share Ex: accountant and auto-mechanic Ex: research team: theory, econometrics and data access Personnel Economics 10 12

13 information set Frisch Information set Engel Personnel Economics 10 13

14 Personnel Economics 10 14

17 Team size Large teams create communication problems Small teams do not have enough info to share Incentive intensity determined by team size: own benefit = return to own effort/group size The larger the team, the more severe is the free-rider problem Peer monitoring more effective in smaller teams Effort is easier to observe in small teams One member s shirking has bigger effect on every other worker, so incentive to punish him is bigger Personnel Economics 10 17

18 Incentives in teams 1. Team bonus 2. Profit sharing 3. Stocks and options 4. Implicit rewards 5. Norms Personnel Economics 10 18

19 1. Team bonus Bonus for finished project, split among members Small groups Well-defined project/output Short duration, so that team remains intact Ex: construction project Ex: football team Personnel Economics 10 19

20 2. Profit sharing Reward based on company profits, typically split in proportion to worker s base salary. Share = (worker j s base annual salary)/total wage bill Team = whole firm Why would somebody set group size so high? Free-rider problem enormous! Workers have their human capital already tied up in one firm, they should diversify their financial capital to reduce risk (ex. ENRON) Important argument against firm-specific pension fund Profit sharing is risk sharing which transfers some of the risk from stockholder to workers ( is typically not optimal and must be compensated) Personnel Economics 10 20

21 Profit sharing in a more positive light Profit sharing can be motivating Symbolic action, can help to internalize firm goals We are one! Intrinsic motivation more important if explicit incentives are difficult to install Create a firm spirit of high-commitment as incentive mechanism Sometimes firm spirit particularly valuable, e.g. if trademark, quality of product is important Personnel Economics 10 21

22 3. Stocks and options Usually for high-level managers Cooperation is very important Impact on firm is big Makes them care about own and other peoples output Personnel Economics 10 22

23 Stocks and options Stock: ownership claim on a corporation Call option: the right to buy stock to the exercise or strike price K at a certain date in the future. In the money : Market price (X) of stock exceeds strike price (K) Out of the money : X < K: Option is not exercised Employee profits from the call option if it is in the money, i.e. the strike price is lower than the market price at pre-specified date. Stock of the firm is an option with strike price=0. Personnel Economics 10 23

24 Value of an option contract Assume an option has a 50 % chance to be worth 90 or 110 each. Current stock price is 100 Assume: you want to give the manager a reward with an expected value of 100. Strike price Value of one option Number of options required Personnel Economics 10 24

25 Value of an option contract The higher the exercise price, the larger the number of options that must be granted to produce a given expected value. Which combination of number/exercise price should firm choose? Consider: value of an option increases as value of firm rises. Personnel Economics 10 25

26 Value of an option contract Example: Action of worker (i..e. high effort of the worker) increases value of firm by 1 mio. There are 1 million shares, so the action raises value of every share by 1. Strike price Number of options required Value of one option (no action) Value of one option (after action) Net value of action to manager Personnel Economics 10 26

27 Value of an option contract Incentive effects differ for options with different strike prices: Large number of options with higher strike price creates higher incentive for manager Leverage effect Managers have incentive to choose more risky projects Option price is higher if Stock price is more volatile Longer period to exercise option Personnel Economics 10 27

28 Why have options become popular? Have been introduced in period of rising stock prices Tax treatment in some countries Good incentive effects for managers Possibility of spreading the risk for the firm (costs relatively low in case of success and nothing in case of failure) Personnel Economics 10 28

29 Effects of options on personnel Attracts persons who are less risk-averse Increases risky decisions of personnel Only useful for managers who can make strategic decisions Reduces turnover, often long duration, useless if worker leaves the firm Little effect for most workers Personnel Economics 10 29

30 4. Implicit rewards Firms usually pay higher wages when they make higher profits (to all workers) Bargaining power of workers is higher Firm does not want to lose workers In most firms, these implicit bonuses account for a bigger share of a firm s wage bill than explicit bonuses. Personnel Economics 10 30

31 5. Can norms help to alleviate group free-riding? Norms are practices a firm engages in or a set of beliefs held in a firm, part of a firm s culture Monitored by peer pressure: e.g. criticism, ostracism (Ächtung) Peers bear ongoing enforcement costs for the norm, punish violators with lower (sometimes also higher) effort levels Norms break down if too often violated and not punished Workers have a hard time to empathize with nameless, faceless shareholders, but more easily with co-workers Creating norms leads to empathy, loyalty and latent guilt Personnel Economics 10 31

32 Group composition People are different, differently suited for different tasks People possess different pieces of information Takes time to convey information, but maybe diminishing returns of doing so Rotating of group members Con: Person-specific HC, takes time to get to know each other and build up trust and communicaton (e.g. people from different disciplines!) Personnel Economics 10 32