Lecture15EmployeeCompensation.pdf

Lecture15EmployeeCompensation.pdf - Motivation Moral Hazard...

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Motivation Moral Hazard Fixed Wage Incentives Multitasking Info Monitoring Economics of Entrepreneurship: Employee Compensation & Motivation University of Michigan
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Motivation Moral Hazard Fixed Wage Incentives Multitasking Info Monitoring Employee Compensation and Motivation From an economic perspective, how might you motivate your employees to work hard? Moral hazard problems Incentive contracts Monitoring
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Motivation Moral Hazard Fixed Wage Incentives Multitasking Info Monitoring Some Forms of Compensation Salary (hourly, monthly, yearly) Incentive pay (e.g. piece rates, commissions) Bonuses Stock options Perks Benefits
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Motivation Moral Hazard Fixed Wage Incentives Multitasking Info Monitoring Some Thing to Think About in Deciding Compensation 1) Can you easily monitor your employee’s performance? 2) Incentives for employee to work hard (avoiding “moral hazard”). 3) Compensation risk for employees. 4) Multitasking 5) Tax issues (we won’t talk more about this).
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Motivation Moral Hazard Fixed Wage Incentives Multitasking Info Monitoring Moral Hazard, I It is typically hard or costly for the employer to ensure an employee is working hard. Hence, employees may not work as hard as their employers want them to. Economic theory calls this a “moral hazard” problem. General idea: employees feel the cost of their effort, but do not necessarily receive the gains to this effort. As a result, they will generally underprovide this effort (called “shirking” in economic theory).
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Motivation Moral Hazard Fixed Wage Incentives Multitasking Info Monitoring Moral Hazard, II A formal model - you’ve hired an employee to work for you as a salesman: e = employee’s chosen level of effort s = total sales = e + x (e.g. in thousands) where x = a random factor that affects sales of product (suppose that on average x = 0). c ( e ) = “psychic cost” to employee of exerting effort level e c ( e ) = 10000 · ( e 2 - 2 e + 2)
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Motivation Moral Hazard Fixed Wage Incentives Multitasking Info Monitoring Moral Hazard, III Consider an employment contract of the form: yearly wage (total compensation) = w = a + b · s There is a fixed part of the compensation (a) and a part that depends on sales ( b · s ) (incentive pay) .
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