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Motivating and

Evaluating Performance

2I 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

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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

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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