Incentive compensation is one of the most powerful tools managers have to motivate and direct their employees—but only if they are used properly! On Wednesday, 4/23 from 1 -- 2 PM EDT join eCornell for a webinar with Cornell University Prof. Robert Bloomfield entitled "Motivating and Evaluating Performance." During the webinar, Prof. Bloomfield will discuss how to: Link performance evaluation and incentives to organizational strategy Revise strategy and operations to accomplish strategic goals at lower cost Help employees collaborate and work together across departments and functional areas, and communicate more effectively with colleagues about the goals and performance of their organization There will be time for a Q&A session with Prof. Bloomfield so you can ensure that you get information relevant to your area of business. This webinar is perfect for managers and leaders, including accounting and finance professionals who are responsible for managing costs, margins, revenue, or efficiency and would like to take a more strategic approach to motivating performance.

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Motivating
and
Evaluating
Performance

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I sure hope she knows how to use that thing!

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Questions about Paying for Performance
Why tie pay to
performance?
What are the unintended
consequences of tying pay
to performance?
How can (and do)
accountants help?
What if people are Homo
Sapiens, not Homo
Economicus?

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Free pdf: http://ssrn.com/abstract=2427106
If you have objectives you wan to
accomplish, this book is for you!
• Are we achieving your
objectives?
• Is our strategy working for
achieving our objectives
working? If not, what should we
do differently? Are we executing
our strategy poorly, or is the
strategy flawed?
• How can we encourage others
to pursue our objectives, rather
than their own?
• How should we reward people
for their contributions?

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Why Pay for Performance?
Motivation
Communication
Risk-Sharing
Screening

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Motivation

7. 7
The Piece Rate System

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Communication

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Risk Sharing

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Why Share Risk?

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Screening

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Principal-Agent Theory

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Choose Your Poison
Low Motivation
High Pay
Costly Reporting
Systems

14. 14
No System is Perfect

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The Participation Constraint

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• I returned, and saw under the sun, that the
race is not [always] to the swift, nor the
battle to the strong, neither yet bread to
the wise, nor yet riches to men of
understanding, nor yet favour to men of
skill; but time and chance happeneth to
them all.
• Ecclesiastes 9:11

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Incentive Intensity, Motivation & Risk

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The Compensating Differential
You need to pay extra to get people to
take risky jobs—even if the risk is “only”
unpredictable pay

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Incentive-Compatibility Constraint

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The Law of Measure Management
Measure
Management
Distorting
operations or
reporting to manage
the measure of
performance, rather
than the underlying
performance the
measure is intended
to capture
Measure
management arises
when measures
capture performance
constructs with
error, the people
being evaluated are
aware of this
fact, and people have
discretion to distort
either operations or
reporting.

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Constructs & Proxies

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The Allegory of the Cave

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The Modern-Day Cave

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Skepticism
A belief that
shadows are
unreliable
representations
of underlying
reality (forms).

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Cynicism
A belief that people
act in their own
self-interest, and
intentionally
creating shadows
that are unreliable
representations of
underlying reality
(forms).

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Imperfect Measures Cause Moral Hazard
• Being insulated
from the full
consequences of
your actions
• Arises when the
principal cannot
distinguish luck
from other factors
that determine
performance
Moral Hazard

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Outputs vs. Outcomes (GASB)
• Measures that quantify the amount of a service
provided. For example, the lane-miles of road
repaired, school graduation rates, number of patients
treated in the emergency room, tons of garbage
collected, or number of fires extinguished.
Outputs
• Measures that gauge the accomplishment or results
that occur at least partially because of the services
provided. They provide a basis for assessing how well a
service's goals and objectives are accomplished.
Outcome measures indicate the quality or effectiveness of
a service.
Outcomes

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Why Governments Care
“Bragging about how
many new schools
you‟ve built counts for
little until children start
graduating with
economically useful skill
sets.
(Link)

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Outcome-Based Contracting
• Charge for
outcome
(reliable
operating time)
not output
(hours of repair)
„Power by
the Hour®‟,

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Is Our Causal Model Correct & Complete?

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Three Problems To Watch For
• Omitted underlying constructs
• Mistaken links between underlying constructs
Flawed Theory
• Poor representations of the constructs
• Omitted variables
Flawed Proxies
• Unintended consequences
Flawed Application

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Implementation Problem # 2
Incentive
Intensity
Slope of Pay-
Performance
Line
Quality of
Performance
Measurement
System
Noise in Proxy
Measures for
Effort
Compensating
Differential
Level of Pay Given
Expected Output
Higher incentive intensity
increases motivation, but imposes
risk on the agent—risk averse
agents will demand higher pay (a
compensating differential)
A better performance
measurement system reduces this
cost of incentive intensity

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In a Nutshell:
• If you have good measures of how hard or smart people are
working, you can base pay on them with high incentive intensity
• The noisier your measures, the lower incentive intensity must be
Output measures
• If you can‟t easily measure how hard or smart people are working, you
must base pay on outcome measures
• Omitted variables make outcome measures uncontrollable, so incentive
intensity can‟t be too high
Outcome measures
• The better your performance reporting system, the more cheaply you
can motivate workers and screen for ability or work ethic
• The worse your system, the more you will have to pay in compensating
differentials and the more you will screen for risk seekers
Performance Reporting Systems

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LIMITATIONS OF THE MODEL

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Effort and Pay are Not Enough
• The head of a Federal
agency might not
agree with the
President‟s goals
• Requires a
“disagreement-based”
model
Agents might care
about the outcome

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Paying for Creative Advertising
• Effort doesn‟t improve
creativity
• Effort can even harm
creativity
Effort might not
improve
performance

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The Crowding-Out Effect
Extrinsic
incentives can
dampen intrinsic
motivation.
Don‟t turn play
into work!
“Fat Kids Who Hate To Read”

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Gamification
Dollars are not
as motivating as
you might think
“Winning” is
motivating, even
if there is no
prize

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Free pdf: http://ssrn.com/abstract=2427106