Lecture 17

Lecture 17 - 6/6/2007 Employee Compensation and Motivation...

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6/6/2007 1 Employee Compensation and Motivation • How can you motivate your employees to work hard? 6/6/2007 – Moral hazard problems – Incentive contracts – Monitoring Some Forms of Compensation • Salary (hourly, monthly, yearly) • Incentive pay (e.g. piece rates, commisions, contingency rates 6/6/2007 contingency rates) • Bonuses • Stock options • Perquisites • Benefits Some Things to Think About in Deciding Compensation • 1) Incentives for employee to work hard (avoiding “moral hazard”). • 2) How well can you monitor your employee’s performance? 6/6/2007 • 3) Alleviating wage risk to employees. • 4) Multitasking • 5) Tax issues.
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2 Moral Hazard - I • Employees may not work as hard as their employers want them to. Economic theory calls this a “moral hazard” problem. This typically arises due to imperfect information 6/6/2007 • This typically arises due to imperfect information, i.e. it is impossible or costly for the employer to ensure the employee is working hard. • General idea: employees feel the cost of their effort, but do not always receive the gains to this effort. As a result, they may underprovide this effort (shirking). Moral Hazard - II • A formal model – you’ve hired an employee to work for you as a salesman: – e = employee’s effort level s = total sales = e + x (e g in thousands 6/6/2007 – s = total sales = e + x (e.g. in thousands) – where x = a random factor that affects sales of product (suppose the mean of x = 0). – c(e) = “cost” to employee of exerting effort level e c(e) = 10000* (e 2 -2e+2) Moral Hazard - III • Consider an employment contract of the form: wage = w = a + b*s • Interpretation of a (fixed wage) and b (incentive pay). 6/6/2007 • Employee’s utility is: U = w – c(e) • The employee will only work for you if he expects U to be greater or equal to 50K. Profits = 100000*s - w
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This note was uploaded on 09/03/2009 for the course ECON 106E taught by Professor Ackerberg during the Spring '08 term at UCLA.

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Lecture 17 - 6/6/2007 Employee Compensation and Motivation...

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