Incentives in Teams

Why Teams?
 * Complimentary - foster coordination and cooperation in an organisation
 * Allows specialisation to occur and specialisation to be used to the max
 * But:
 * Difficult to identify individual effort from the team effort
 * Difficult to evaluate individual effort from team effort

Pay for "Team"-Performance
 * Team Output can only usually be measured aggregately and individual effort is not seen
 * The externalities of teamwork is from the interaction between the team members
 * Complementaries occur when the team works together and it benefits the entire team
 * A team working together as a sum is better than the individuals
 * One member putting in effort improves the team in general


 * This creates a problem of freeriding
 * The actions of one individual benefits the group so this is the case of a private provision of a public good.
 * Since the entire team benefits, some members of the team shall not contribute as they can benefit from the team effort itself.
 * As a result, the team members that contributed will not be rewarded accordingly for the disproportionate effort they put in.
 * Lack of coordination may also be a cause of free-riding as work is not distributed properly over the team members.

First Best Effort(in partnerships) and reducing free-riding
 * Partnerships mean that output is shared among the team members
 * Output/Revenue is a1+a2+a3+....an
 * Cost per worker is 1/2*a^2
 * Marginal team output dP/da = Marginal personal cost dC/da => Team-surplus maximising output
 * Suppose output is shared among the team by s1+s2+s3+.....sn = 1
 * So a given worker's utility is = si(a1+a2+a3......an) - 1/2*ai^2
 * Worker puts in the effort du/da = dC/da = ai = si
 * Whenever si < 1, worker will under-provide effort
 * Inducing first best effort to prevent freeriding would involve giving all of the profit to the workers which is not desirable
 * Question solving
 * the objective is finding a*, the optimum hours that the worker will put in as work
 * Surplus is R - total personal Cost
 * Maximise S to find optimum a*
 * utility function is revenue share - personal cost
 * For finding a* in a freeriding situation, we differentiate the utility function of the worker to find a*
 * the utility function for this is the same, Revenue share - personal cost
 * Make pay system so that workers get paid only if they put in effort ~> Quota system
 * This makes each worker pivotal
 * Question solving burning money:
 * Worker utility function has two branches - one if the target is met and the other if the target is not
 * If not met the utility will be 0 - personal cost. Otherwise it would be revenue share - personal cost.
 * Revenue = (number of employees,n-1)*optimal worker hours + worker's working hour a
 * Personal share would be above divided by 1/n
 * Compare revenue share gained to personal cost to find best response
 * Think slowly!
 * Drawback of steep team incentives
 * If everyone puts in one unit of output, the output will be shared completely among workers
 * But if one worker puts in no effort, the output becomes n-1
 * The output is not there. What happened to it? Does it get destroyed? Are the nonworking members of the team rewarded with the output(Budget Breaking).
 * Multiple equilibria - workers work as long as they believe the other will work
 * Based on belief that others will work so if the belief is weak, worker will not put in work
 * Weak self-enforcing equilbrium
 * Budget Breaking as Debt Financing
 * Firm takes a loan of D with a commitment to repay it with a guarantee (bonus?) of b to each worker
 * D = n - nb
 * If output is at least n, then firm repays D and pays each worker b
 * If output exceeds n, excess is paid to workers equally
 * If unable to make enough, bankruptcy and firm owned by creditor
 * Bankruptcy ensures that work is done by the team members

Pay for Individual and Group-Performance
 * How much to base compensation on group-performance or individual performance?
 * Individual performance better for measuring individual behaviour
 * Group performance allows individuals to take into account of their individual behaviour on the team
 * Pay on group performance may improve individual behaviour
 * RPE - Relative Performance Evaluation, performance of an individual evaluated in terms of another person's performance, promotes non-cooperation. Performance of others increase, pay of individual decreases. Used for: Benchmarking and Tournaments
 * JPE - Joint Performance Evaluation, performance of an individual evaluated in terms of the performance as a team, promotes cooperation. Performance of others increase, pay of individual increases. Useful for: Internalising externalities and fostering cooperation
 * Benchmarking
 * Two risk averse workers exist P1 = a1 + e(common risk) and P2 a2 + e(common risk)
 * Profit = sum of efforts = a1 + a2
 * Basing pay on individual effort/performance means worker bears risk
 * Comparing each worker to average performance eliminates the risk P1 - (P1+P2)/2
 * Firm can induce first best effort in spite of workers risk aversion
 * Comparing performance to others filters out common noise and infers lower risk to workers and increase individual incentives
 * Cooperation vs Incentive
 * Paying for group performance incentivises cooperation and internalising externalities for the benefit of the group
 * But since group performance is evaluated for individual pay, there is a possibility of free-riding
 * Tradeoff between internalising externalities and free-riding
 * Individual performances of P1 = a1 + ya2, P2 = a2 + ya1
 * Private cost = 1/2*a^2
 * Firm pays with individual performance APi and other team member performance BPj
 * utility of worker 1, u1 = (A-B)P1 + B(P1+P2) - 1/2*a^2
 * firm pays B for joint performance and A-B for individual performance
 * How would a worker change in individual and group pay?
 * u1 = A(a1+ya2) + B(a1+ya2) - 1/2*a^2 = (A+By)a1 + (By+A)a2 - 1/2*a^2
 * worker 1 thus puts in effort A+By with individual pay increasing performance and group pay change effect depends on the externality

Focused vs Broad based incentives
 * Read slides
 * TDR Broad based is better