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Time Rate vs Piece Rate (Piece Rate (Connect wage to some measure of…
Time Rate vs Piece Rate
Piece Rate
- Connect wage to some measure of workers' output
- Used by firms when it is cheap/easy to monitor the output of workers
Problems:
- Difficult to distinguish individual output/effort
- Possible diminishing of quality/non-contractible qualities
- If output is not strictly connected with effort, workers might experience huge fluctuations of income
- Free-rider problem: piece rate pay in team production creates bad incentives
- Ratchet effect: Discourages workers from improving productivity in fear of a pay rate cut (if employer mistakenly thinks that the job is easy)
It is cheaper for able workers to produce the same output as low-ability workers. Thus, for same piece rate, able workers will produce more output and earn more than low-ability workers.
Preferred by high-ability workers. Also preferred by less risk-averse workers and workers who are more responsive to incentives.
Time Rate
- Worker is paid a fixed amount per period of time she works
- Mainly used by firms when it is costly or impossible to monitor the output of workers
Employers fire workers if they produce below a basic level of output. Thus, both low-ability and able workers will produce this basic level of output and are paid a fixed wage.
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CEO Compensation
CEO compensation:
- Base pay
- Bonus: dependent on the performance of the company
- Share compensation: Trying to make the CEO an "owner" of the company, thus alleviating the principal-agent problem
Bell & Van Reenen (2016)
- CEO's real wage did not decrease since 2010 unlike the median worker + top 1%
- CEO compensation sees lower % coming from base salary, and higher % coming from bonuses/share compensation
- CEOs in companies with institutional ownership are rewarded for gains and punished for losses
- CEOs in companies without institutional ownership are rewarded both for gains and losses
Reasons for Premium
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Tournament
High salary of the CEO is to incentivise all the power below the CEO to exert effort, keeping in mind one of them will succeed as the next CEO
Workers allocate more effort when the prize spread between winner and loser increases. Optimal spread should be large enough to induce the efficient level of effort, but not so high as to exceed it.
- If there are more competitors in the tournament, we have to increase the incentive
- In order to win the tournament, competitors may start taking risky projects in order to try and win the tournament
- Other pitfalls can include a bad workplace atmosphere, risk of cheating/sabotage, etc.
Incentive packages may induce risky behaviour
- Assume 2 projects with same expected profits but different risk levels
- Shareholders prefer the project with smaller risk due to the same expected profits
- CEOs on the other hand will prefer the project with bigger risk
- If project succeeds, the CEO gets rewarded due to the incentive packages
- If the project fails, CEOs are still "protected" by base pay
Note: Having base pay induces the CEO to go for more risky projects!