Performance Incentives and the Dynamics of Voluntary Cooperation

1. Performance Incentives and the Dynamics of Voluntary Cooperation Simon Gächter (University of Nottingham) Esther Kessler (University College London) Manfred Königstein (University of Erfurt)

2. Motivation • Many employment contracts are incomplete • “Voluntary cooperation” of the agent is important: • “Managers claim that workers have so many opportunities to take advantage of employers that it is not wise to depend on coercion and financial incentives alone as motivators” (Bewley, 1999) • “work morale”, “creativity”, “loyalty”, “initiative”, “Good will”, etc. (Williamson 1985; Simon 1997; Bewley 1999) • “Organizational citizenship behaviour” (Organ 1988) • Explicit performance incentives quite popular

3. A simple model: adapted from Fehr, Kirchsteiger & Riedl (QJE 1993) Participants are randomly assigned to the roles of “employer” and “worker”, respectively. 1. Employer: 2. Worker: 3. Payoffs realised – Accept/reject offer– Choose costly effort [1, 2, …, 20] Wage offer [0,700] Motivation (2) • Incomplete contract, because effort not specified • Worker payoffs: w – c(e) (costs increasing in effort) • Employer payoffs: ve – w (revenues increasing in effort)

4. Motivation (3) Fehr, Kirchsteiger & Riedl (QJE 1993):  There is reciprocity-based voluntary cooperation

5. Motivation (4) • Starting ideas for our experimental study: • Do explicit incentives crowd out voluntary cooperation? • Can voluntary cooperation be re-established after experiencing incentive pay? • Since we know from other experiments that framing of incentives and repeated game effects are also potentially relevant for behavior, these should be studied as well

6. Motivation (5) • We investigate in a unified framework: • 1. Existence of voluntary cooperation • 2. Effectiveness of monetary incentives • 3. Crowding out effects • 4. Framing effects (Bonus vs Fine) • 5. Repeated game effects

7. Experimental Game • Principal-agent game: • Principal offers work contract • Agent can accept or reject • Agent chooses effort • Contract and effort determine payoffs

8. Experimental Game (2) w  [-700, 700] ê  [1, 20] b{0,24,52,80} w [-700, 700] ê  [1, 20] - w  [-700, 700] ê  [1, 20] f {0,24,52,80} 35e – w 35e–w if e≥ê 35e–w+f if e<ê 35e–w–b if e≥ê 35e–w if e<ê w – c(e) w –c(e) if e≥ê w –c(e)–f if e<ê w –c(e)+b if e≥ê w –c(e) if e<ê Effort cost: c(e) = 7e – 7 Payoff if contract rejected: 0 for both

9. Standard Theoretical Predictions • Trust Contract: • e = 1 (minimal effort) • Fine Contract, Bonus Contract: • e = ê if fine is sufficiently large: f  c(ê)(“incentive compatibility”) • Otherwise, e = 1 • Equivalent for bonus (framing of incentives) • Higher fine/bonus induces higher effort: f ,b  {0, 24, 52, 80} enforceable effort levels: {1, 4, 8, 12} • limited possibility for sanctions/rewards

10. A Comprehensive Experimental Design (1) Random matching in each period to minimize strategic effects

11. A Comprehensive Experimental Design (2)

12. Procedures • Experiments at the University of St. Gallen • Computerised, z-Tree (Fischbacher 1999) • 456 participants • CHF 45 (€30) for 1.5 – 2 hours

13. Results

14. Voluntary cooperation exists and is stable over time Period 1-10 Period 11-20 Period 21-30

15. Higher incentives induce higher effort • 68% of all contracts are incentive compatible • Most principals (about 90%) choose maximal fine, bonus

16. TRUST Partner vs. Stranger FINE Partner vs. Stranger BONUS Partner vs. Stranger

17. Results From These Graphs • Trust contracts can induce high effort (“trust-and-reciprocity” is an important mechanism) • Monetary incentives are effective • Repeated interaction has strong effect • Framing (Bonus vs Fine)? • Crowding out of voluntary cooperation?

18. How to proceed? • Evaluate these effects within a unifying statistical model • Convincing structural model? • Effort is bounded below and above  Tobit-Regression • But, take a look at the distribution of data again

19. Distribution of effort conditional on wage Period 1-10 Period 11-20 Period 21-30 Two groups of data: • e=1 independent of fixed wage • e>1 positively correlated with fixed wage

20. Robustness of Data Pattern TFT TTT-Partner FT BT TFT-Partner TBT-Partner TBT

21. How to proceed? •  Hurdle Model 1. Estimate p = prob(e>1) 2. Estimate ê = f(x|e>1) For Step 2 use Tobit with upper bound 20 • But, take another look at the distribution of data

22. Distribution of effort conditional on best reply effort Three groups of data: • e=1 independent of best reply effort • e=e* • other choices

23. Robustness of Data Pattern TFT (left), TBT (right) TFT-Partner (left), TBT-Partner (right)

24. How to proceed? •  Double Hurdle Model 1. Estimate p = prob(e>1) 2. Estimate q = prob(e=e*|e>1) 3. Estimate ê = f(x|e>1 and e≠e*) For Step 3 use Tobit with upper bound 20

25. Can trust contracts do better than incentive contracts? • Applying this structure we evaluate effectiveness of trust contracts, monetary incentives, repeated game, framing, crowding out • Important question: Can trust contracts perform better than incentive contracts (cet. par.)? • We need to compare trust contracts with equally expensive incentive contracts; i.e., holding total compensation constant • Use estimates of p, q and ê to determine expected effort for payoff-equivalent contracts

26. Yes! Trust contracts can do better than incentive contracts Data: FT, BT, only incentive compatible contracts

27. Robustness: 3-Phases-Data Stranger Data: TFT, TBT, only incentive compatible contracts

28. Robustness: 3-Phases-Data Partner Data: TFT-Partner, TBT-Partner, only incentive compatible contracts

29. Summary • Trust contracts and monetary incentives are both effective in inducing effort • We find substantial crowding out of voluntary cooperation due to incentives; if the contract is incentive compatible most subjects exactly choose rational effort • Trust contracts may be more beneficial for a principal than an incentive compatible contract with bonus or fine • Other results: Repeated game important, framing relatively unimportant • Interestingly, non-incentive compatible contracts perform relatively well (further analyses needed)