Academic journal article Monthly Labor Review

Performance Measures and Incentive Plans

Academic journal article Monthly Labor Review

Performance Measures and Incentive Plans

Article excerpt

It is critical for firms to find effective ways to measure the performance of their employees and to create systems of incentives that spur them to make decisions that increase profit. Yet performance measurement is typically a very difficult task, and economists have yet to fully understand incentive plans. "Performance Measure Properties and Incentive System Design" (Industrial Relations, April 2009, pp. 237-64), a recent article by Michael J. Gibbs, Kenneth A. Merchant, Wim A. Van Der Stede, and Mark E. Vargus, builds upon earlier work on this subject by constructing and analyzing a data set on the basis of survey responses from managers in auto dealerships.

The authors analyze four properties of performance measures: controllable risk, uncontrollable risk, distortion, and manipulability. Controllable risk is uncertainty to which the agent can react, whereas uncontrollable risk is uncertainty to which the agent is not able to react. Distortion occurs when an incentive encourages employees to misallocate their efforts--for instance, to focus on short-term rather than long-term goals. When an employee "works the system" and increases his or her reward from an incentive plan at the expense of the firm, the employee has taken advantage of the manipulability of the incentive plan. Most auto dealerships were found to use more than one type of performance measure. …

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