The following is a brief summary of a working paper published by the National Bureau of Economic Research on the effects of bonus-pay schemes in firms where workers’ output is judged on multiple dimensions including quality.
Principal-agent relations present an omnipresent feature to modern economies. The fundamental issue is that the worker (the agent) has more information about their actions than the person employing them (the principal) and, without proper incentives, the relationship generally yields less than efficient outcomes. For example, a worker in a firm usually knows more about how hard they are working and how their effort translates to productivity than the owner does. This study dives into the problem that arises in factories utilizing bonus schemes that incentivize productivity but do not account for all dimensions of output. The theory predicts that doctors will focus on the rewarded measures as a result of this payment scheme. However, it may have adverse effects on other aspects that are unmeasurable or unaccounted for in the scheme. Recent policy debate concerning pay for performance to doctors in New York City public hospitals embodies this problem – “while doctors will receive raises based on some quality measures, such as patients’ rating of doctors’ communication effort, promptness in the operation room, and the speed of service, many other quality aspects of health care will not be measured.”
This study examines how incentive contracts affect agents’ effort choice in contracted and not contracted dimensions in Chinese factories. The base salary structure of workers in the sample varies by factory and production process – factories employing team-based production processes usually choose flat rate salary schemes; individually manufactured products likely employed piece rate contracts. The general prediction was that a bonus scheme focusing on output would incentivize workers to increase their per hour productivity but lead to a decrease in the quality of each unit produced.
The Framework
An agent chooses a level of effort e = (e1, e2) for any given task. The first dimension of effort e1 directly affects the quantity of output, whereas the second dimension e2 affects the quality of output. To provide a level of effort e, we assume that an agent faces an effort cost of C(e). The principal offers the agent a wage of y + a0e1 where y is a fixed payment, and a0 > 0 is a piece-rate payment on the visible component of effort (e1). Give this offer, the agent will choose the effort level e* such that: e* = max y + a0e1 – C(e)
Predictions
- An agent offered a flat rate of pay, a0 = 0, would choose the minimum level of effort
- An agent offered a piece-rate a0 > 0 will increase the effort on the observable component of effort (quantity) while reducing effort on the unobservable component of effort (quality)
The Results
- Incentives work: Compared to baseline productivity, the workers increased their productivity by 25.6% on average, when they received monetary incentives. The effect was much stronger for workers paid with fixed hourly wages (50.1%) compared to workers whose base salaries were paid by piece rates (4.9%). What these findings imply is that workers paid under piece-rate salaries produce closer to their maximum output compared to those paid fixed wages.
- Higher productivity = lower quality: Although workers increased their productivity as a result of the bonus scheme, their quality of production decreased. Specifically, workers increase their defect rates by 61.3% under the bonus scheme. Even though workers knew that quality was imperative, they shrugged it off for a higher bonus.
ABSTRACT
A well-recognized problem in the multitasking literature is that workers might substantially reduce their effort on tasks that produce unobservable outputs as they seek the salient rewards to observable outputs. Since the theory related to multitasking is decades ahead of the empirical evidence, the economic costs of standard incentive schemes under multitasking contexts remain largely unknown. This study provides empirical insights quantifying such effects using a field experiment in Chinese factories. Using more than 2200 data points across 126 workers, we find sharp evidence that workers do trade off the incented output (quantity) at the expense of the non-incented one (quality) as a result of a piece rate bonus scheme. Consistent with our theoretical model, treatment effects are much stronger for workers whose base salary structure is a flat wage compared to those under a piece rate base salary. While the incentives result in a large increase in quantity and a sharp decrease in quality for workers under a flat base salary, they result only in a small increase in quantity without affecting quality for workers under a piece rate base salary.
AUTHORS
Fuhai Hong – Division of Economics, Nanyang Technological University
Tanjim Hossain – Rotman School of Management, University of Toronto
John A. List – Department of Economics, University of Chicago
Migiwa Tanaka – Department of Economics, University of Toronto
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