Canice Prendergast

The Tenuous Trade‐off between Risk and Incentives

Empirical work testing for a negative trade‐off between risk and incentives has not had much success: the data suggest a positive relationship between measures of uncertainty and incentives rather than the posited negative trade‐off. I argue that the existing literature fails to account for an important effect of uncertainty on incentives through the allocation of responsibility to employees. When workers operate in certain settings, firms are content to assign tasks to workers and monitor their inputs. By contrast, when the situation is more uncertain, they delegate responsibility to workers but, to constrain their discretion, base compensation on observed output.

Impetuous Youngsters and Jaded Old-Timers: Acquiring a Reputation for Learning

This paper examines individual decision making when decisions reflect on peoples ability to learn. We address this problem in the context of a manager making investment decisions on a project over time. We show that in an effort to appear as a fast learner, the manager will exaggerate his own information; but ultimately, he becomes too conservative, being unwilling to change his investments on the basis of new information. Our results arise purely from learning about competence rather than concavity or convexity of the rewards functions. We relate our results to the existing psychology literature concerning cognitive dissonance reduction.

The Role of Promotion in Inducing Specific Human Capital Acquisition

Workers routinely carry out activities that increase their productivity with their current employer for which they are not directly compensated. For example, a worker may be asked to develop relationships with clients or shop floor staff, or he may develop a better understanding of how his firm operates. Firmspecific human capital of this type is difficult to quantify so that it is likely to be difficult to directly compensate the worker for its acquisition. This paper is concerned with designing compensation schemes for employees to induce them to collect nonverifiable firm-specific human capital. If firms develop reputations for fairly compensating workers for skill collection, the vagueness of these skills may not provide a significant incentive problem. I consider the case where firms do not have the opportunity to develop reputations. As a result, the acquisition of human capital is subject to a dual moral hazard problem, first noted in Kahn and Huberman [1988]. First, a worker only collects skills if there is a promise of a higher wage if he does so. Second, the employer has an incentive to claim that the worker has not collected these skills even when he in fact has, in order to save on wage costs. So, on the one hand, it is difficult to repay the worker after skills are collected as the firm has an incentive to renege. However, the worker cannot be repaid before collecting skills as he has no subsequent incentive to collect them. Following the institutional literature, I assume that the firm can commit to a labor contract which attaches wages to different tasks. The principal purpose of the paper is to show that the firm can use this ability to commit to a wage scale for different tasks to induce a worker to collect firm-specific human capital in the presence of this dual moral hazard problem, where the worker is rewarded for skill acquisition by promotion to another job. Assume that a worker can be assigned to one of two jobs, D and

Discretion and bias in performance evaluation

Most of the economics literature on compensation and organizations builds from the theory of agency.’ For the most part, the literature analyzes situations in which agents’ performance can be controlled by tying compensation to objective performance measures such as output or sales. It ignores the fact that most compensation arrangements involve superiors’ subjectire. and hence non-contractible. judgements about employee performance. In our view, much of what is interesting about actual employment relations follows from the observation that ‘performance appraisal is a process by which humans judge other humans’ [Milkovich and Wigdor (1991)]. This paper studies the implications of subjective performance evaluation for compensation policies and for the efficiency of employment relations. Our objectives are two fold. First. we propose the importance of subjectivity of evaluations to better understand organizatlonal practices such as politicking, favoritism. and compression of wage scales. Second, we hope to orient the study of subjective performance evaluation in ways that are consistent with empirical evidence on what organizations actually do.

Uncertainty and Incentives

Empirical work testing for a trade‐off between risk and incentives has had, at best, mixed success. This article provides two simple reasons, associated with subjectivity of performance appraisals, why we might not expect to see any negative relationship. Both reasons relate to empirically observed problems associated with monitoring: (i) supervisors sometimes bias their evaluations based on their personal feelings toward their subordinates, and (ii) supervisors will sometimes offer evaluations that reduce their costs. These aspects of monitoring are ignored in the standard model and can reverse the usual negative trade‐off between risk and incentives.

The limits of bureaucratic efficiency

Bureaucracies tend to be used when consumers cannot be trusted to choose outcomes efficiently. But a primary means of bureaucratic oversight is consumer complaints. But this can give bureaucrats an incentive to inefficiently accede to consumer demands to avoid a complaint. I show that when this incentive is important, bureaucracies (efficiently) respond by (i) ignoring legitimate consumer complaints, (ii) monitoring more in situations in which it is not needed, (iii) delaying decision making “too long,” and (iv) biasing oversight against consumers. I also show that bureaucracies are used only when consumers cannot be trusted. As a result, observed bureaucracies are always inefficient.

The Non-Monetary Nature of Gifts

This paper addresses the prevalence of non-monetary gifts over more highly valued and e

Career Development and Specific Human Capital Collection

cient monetary transfers in social relationships. We demonstrate that under a wide variety of circumstances, ine

Merger Failure and Merger Profitability

cient non-monetary gifts will be o!ered by a donor in lieu of cash in order to signal the donors quality of information about the recipients preferences. This result emerges because gift giving is ine

Restricting the Means of Exchange within Organizations

cient relative to cash, and not because of any arbitrary assumptions regarding communication. In particular, the donor has available the strategy of o!ering cash and saying what he would have purchased. Nonetheless, there is still an important equilibrium role for buying gifts. 2001 Elsevier Science B.V. All rights reserved. JEL classixcation: A13; D10; D64; D82; Z1