Relative Reward

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Relative Rewards within Team-Based Compensation
BERND IRLENBUSCH and GABRIELE K. RUCHALA

December 2006 Abstract
How to design compensation schemes to motivate team members appears to be one of the most challenging problems in the economic analysis of labour provision. We shed light on this issue by experimentally investigating team-based compensations with and without bonuses awarded to the highest contributors in teams. A purely team-based compensation scheme induces agents to voluntarily cooperate while introducing an additional relative reward increases effort and efficiency only when the bonus is substantial. In this case, however, the data suggests that tournament competition crowds out voluntary cooperation within a team.

Keywords Teamwork; Bonus Pools; Relative Rewards; Motivation Crowding Out; Voluntary Cooperation; Personnel Economics; Experiments

JEL Classification Codes C72; C91; H41; J33; L23; M52

Authors Bernd Irlenbusch London School of Economics Department of Management (MES) Houghton Street London WC2A 2AE United Kingdom tel: +44-20-7955-7840 fax: +44-20-7955-6887 e-mail: b.irlenbusch@lse.ac.uk

Gabriele Ruchala University College London Department of Economics (ELSE) Gower Street London WC1E 6BT United Kingdom tel: +44-20-7679-5852 fax: +44-20-7916-2774 e-mail: g.ruchala@ucl.ac.uk

We thank two anonymous referees, David Dickinson, Andrea Ichino, Manfred Königstein, and Dirk Sliwka for very helpful comments to improve the paper. All errors are our own. Financial support by the Deutsche Forschungsgemeinschaft (through grants IR43/1-1, KR2077/2-1 and KR2077/2-3) and by the Economic and Social Research Council (via ELSE) is gratefully acknowledged.

1. Introduction Teamwork is increasingly seen as an appropriate structure to organise various labour environments (BEYERLEIN 2000, MUELLER, PROCTER, and BUCHANAN 2000, PRAT 2002, ZWICK 2004, VAN

HOOTEGEM, BENDERS, DELARUE, and PROCTER 2005). The suitable

provision of incentives for teams, however, appears to be one of the most challenging tasks in labour economics (MAIN, O’REILLY, and WADE 1993, DEMATTEO, EBY, and SUNDSTROM 1998, HAMILTON, NICKERSON, and OWAN 2003). In general wage contracts of teams are not conditioned on individual contributions (as it is the case in piece rate contracts) because contributions can neither be (easily) disentangled nor verified before a court. This is one of the reasons why team members are often rewarded according to the output of the team as a whole. Another purpose is to encourage cooperative behaviour in the sense that individual team members strive for the best outcome of the whole team. From a strategic point of view, however, such a scheme provides considerable free-riding incentives, which might lead to inefficient effort levels (see, for example, ALCHIAN and DEMSETZ 1972, NEWHOUSE 1973, HOLMSTRÖM 1982, HANSEN 1997). An intuitive approach to reduce the severity of free-riding incentives in teams is to promise relative rewards to the best individual performers in the team (HENEMAN and VON

HIPPEL

1995). In practice relative rewards within teams often take the form of bonuses1 (for example, for the “employee of the month”) or promotions which imply higher salaries. One reason why relative rewards are so popular stems from the fact that output needs only to be measured relatively which constitutes a big advantage when absolutely measuring individual outputs is prohibitively costly. Even if the individual contributions of team members are not verifiable to a third party, the employer can commit himself to a relative incentive scheme. The commitment is credible as long as the individual (relative) outputs are observable (for example by the team leader) and the act of actually transferring the ex-ante promised relative

The total amount of the bonuses usually varies with the size of the bonus pool which is determined by some objective measures like overall corporate profit. How the bonuses are...
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