Florian Ederer

Is Pay for Performance Detrimental to Innovation

Previous research in economics shows that paying the agent based on performance induces the agent to exert more effort thereby enhancing productivity. On the other hand, research in psychology argues that performance-based financial incentives may inhibit creativity and innovation. In a controlled laboratory experiment, we provide evidence that the combination of tolerance for early failure and reward for long-term success is effective in motivating innovation. Subjects under such an incentive scheme explore more and are more likely to discover a novel business strategy than subjects under fixed-wage and standard pay-for-performance incentive schemes. We also find evidence that the threat of termination can undermine incentives for innovation, while golden parachutes can alleviate these innovation-reducing effects. Our results suggest that appropriately designed incentives are useful in motivating creativity and innovation.

Feedback and Motivation in Dynamic Tournaments

We investigate the choice to conduct interim performance evaluations in a dynamic tournament. When a workers ability does not influence the marginal benefit of effort, the choice depends on the shape of the cost of effort function. When effort and ability are complementary, feedback has several competing effects: it informs workers about their relative position in the tournament (evaluation effect) as well as their relative productivity (motivation effect) and it creates signal-jamming incentives to exert effort prior to the performance evaluation. These effects suggest a tradeoff of performance feedback between evaluation and motivation which is in accordance with organizational behavior research and performance appraisal practices.

Incentives for Parallel Innovation

Learning from the experiences of other innovators is a crucial aspect of the innovation process when several workers or teams explore new research avenues in parallel. In such a setting, under-exploration may result as workers attempt to free-ride on the new ideas generated by co-workers. This paper studies optimal incentive schemes for innovation and shows that when workers can learn from each others experience, incentives for innovation fundamentally differ from incentives for routine activities. Optimal incentives for routine activities take the form of standard pay-for-performance where only individual success determines compensation. In contrast, the optimal incentive scheme for parallel innovation tolerates early failure and provides workers with a combination of long-term individual and group incentives for joint success. This result is in line with the empirical regularity documented in previous work that team compensation, profit sharing, employee ownership, and stock option plans are positively correlated with innovative activity. I further show that there exists a causal link between such incentives and innovation. When subjects in a controlled laboratory experiment are asked to perform a task that requires creativity and exploration, they attempt to free-ride on the exploration of others if given standard pay-for-performance contracts. Innovation success and performance is highest when subjects receive a mix of individual and group incentives that reward long-term joint success.

Common Ownership, Competition, and Top Management Incentives

When one firm’s strategy affects other firms’ value, optimal executive incentives depend on whether shareholders have interests in only one or in multiple firms. Performance-sensitive contracts induce managerial effort to reduce costs, and lower costs induce higher output. Hence, greater managerial effort can lead to lower product prices and industry profits. Therefore, steep managerial incentives can be optimal for a single firm and at the same time violate the interests of common owners of several firms in the same industry. Empirically, managerial wealth is more sensitive to performance when a firm’s largest shareholders do not own large stakes in competitors.

The Persistent Power of Promises

Using a large-scale hybrid laboratory and online trust experiment with and without pre-play communication, we investigate how the passage of time affects trust, trustworthiness, and cooperation. Communication (predominantly through promises) raises cooperation, trust, and trustworthiness by about 50 percent. This result holds even when three weeks pass between the time of the trustees message/the trustors decision to trust and the time of the trustees contribution choice and even when this contribution choice is made outside of the lab. Delay between the beginning of the interaction and the time to reciprocate neither substantially alters trust or trustworthiness nor affects how subjects communicate.Using a large-scale hybrid laboratory and online trust experiment with pre-play communication this paper investigates how the passage of time affects trust, trustworthiness, and cooperation. We provide evidence for the persistent power of communication. Even when three weeks pass between messages and actual choices and even when these choices are made outside of the lab, communication (predominantly through the use of promises) raises cooperation, trust, and trustworthiness by about 50 percent. Delays between the beginning of the interaction and the time to reciprocate neither substantially alter trust or trustworthiness nor affect how subjects choose to communicate.