1.IncentiveProblemHowcanIncentiveProblemsbeSolved?IncentiveProblems can be solved througheffective compensationcontractsCompensation contracts have two functions-Motivate employees-ShareriskmoreefficientlyProfDr.Birgitta WolffBejing, Sept.2002MarjaanaRehu,MA
Prof. Dr. Birgitta Wolff Marjaana Rehu, M.A. 1. Incentive Problem How can Incentive Problems be Solved? • Incentive Problems can be solved through effective compensation contracts • Compensation contracts have two functions − Motivate employees − Share risk more efficiently Beijing, Sept. 2002
2. Compensation ContractsCompensation ContractsVariablePayFixed SalaryPayment by OutputPayment by InputSubjectiveSubjectiveObjectiveObjectivePerformancePerformancePerformancePerformanceMeasuresMeasuresMeasuresMeasuresProf.Dr.Birgitta WolffBejing, Sept. 2002MarjaanaRehu,MA
Prof. Dr. Birgitta Wolff Marjaana Rehu, M.A. 2. Compensation Contracts Variable Pay Fixed Salary Compensation Contracts Payment by Output Payment by Input Subjective Performance Measures Objective Performance Measures Subjective Performance Measures Objective Performance Measures Beijing, Sept. 2002
2.CompensationContractsPayment by Input versus Payment by OutputVariable PayStraight Salary(payment by output)(payment by input)CompensationdependsonmeasureCompensationdependsontheamountof what comes outof time or effort spent on an activity Amount of time spent on work doesIndependent of output considerationnot affect workers’compensationProblem:Problem:=InputalsonotalwayseasytomeasureTime at work as a proxy in order to= Output not always easy to measureassess workers effortExamples:Examples:Wageperworkhour Agricultural workers: piece rates p.tray. Monthly salaries. A salesperson on straight commissionAnnualsalaries. Compensation oftopexecutives bystocks or stockoptionsProf. Dr. Birgitta WolffBejing, Sept.2002Marjaana Rehu, M.A
Prof. Dr. Birgitta Wolff Marjaana Rehu, M.A. Variable Pay (payment by output) Straight Salary (payment by input) • Compensation depends on measure of what comes out • Amount of time spent on work does not affect workers‘ compensation Problem: Output not always easy to measure Examples: • Agricultural workers: piece rates p. tray • A salesperson on straight commission • Compensation of top executives by stocks or stock options • Compensation depends on the amount of time or effort spent on an activity • Independent of output consideration Problem: Input also not always easy to measure • Time at work as a proxy in order to assess worker‘s effort Examples: • Wage per work hour • Monthly salaries • Annual salaries 2. Compensation Contracts Payment by Input versus Payment by Output Beijing, Sept. 2002