Incentive Schemes

Abstract

We investigate how the convexity of a firm‟s incentives interacts with worker overconfidence to affect sorting decisions and performance. We demonstrate experimentally that overconfident employees are more likely to sort into a non-linear incentive scheme over a linear one, even though this reduces pay for many subjects and despite the presence of clear feedback. Additionally, the linear scheme attracts demotivated, underconfident workers who perform below their ability. Our findings suggest that firms may design incentive schemes that adapt to the behavioral biases of employees to “sort in” (“sort away”) attractive (unattractive) employees; such schemes may also reduce a firm‟s wage bill.

Introduction

As economists‟ understanding of behavioral biases exhibited by individuals has deepened, an emerging literature has investigated how firms can best adapt their pricing, incentive and contract offerings in light of these biases. Several papers have studied how consumer biases affect the optimal pricing...