econ 308 midtrm 2 part 2
Terms
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- wage compression
- D-is the situation when new hires are paid more than experienced workers. One explanation is that new hires bring in new ideas that are potentially valuable, while on-going workers on routine tasks gain minimal value from experience.
- back load compensation
- D- is when compensation increases faster than productivity as an employee ages, for example, professional services such as law and accounting firms. workers choose back-loaded compensation if productivity of workers increases rapidly over time but with uncertainty. -firms frequently offer attractive retirement packages to encourage older employees to retire and often have mandatory retirement age.
- costs of cafeteria plans
- D- higher adminstrative costs -adverse selection
- examples of incentive compensation
- D-piece rate and commission - bounuses or promotion for good performance -prizes for winning contests eg a free vaction -stock optionand profit sharing plans -demotion and firing upon poor performance
- in some cases, incentive conflicts can be resolve even when efforts are not observable
- D-one way is to "sell" the output to the employees so that both benefits and costs are internalizaed by employees and thus employees will choose the optimal efforts
- from incentive standpoint it is better to tie pay to performance eg stock option
- D-An optimal compensation contract must strike a balance between these two standpoints
- incentive compensation contract works best when
- D-marginal productivity of employees are high -the lower is risk aversion of employees -uncontrollable random events are minimal -the lower is the marginal cost of effort -the lower is the cost of observing and verifying the output of employees
- informativeness principle
- D-states that improvement in the precision of measuring employees effort by incorporating more information of employees effort reduces the cost of ineffiecient risk sharing and leads to a more efficienty effort choice by employees.
- group incentive plans
- D-are incentive pay to an employee based on group performance, such as overall profitability of a firm as reflected by stock prices
- benefits of group incentive plans
- D-group performance measure is less costly than individual performance measure -encourage cooperation and teamwork -motivate mutual monitoring and enforcement among employees
- employee performance is evaluated
- D- to provide employees with feedback on job achievement to improve performance -to determine rewards and sanctions
- ratchet effect
- D- referws to basing next years target performance on this years actual performance leading to a perverse incetive for employees not to exceed this years target performance to avoid raising next years performance.
- methods to reduce the ratchet effect
- D-set next years target based on this years peer actual performance -introduce more frequent job rotation at the cost of losing learning curve effect -make a commitment not to change next years target
- opportunism
- D-is the non or counter productive activites engaged by employees to improve their performance evaluation leading to gaming and horizon problem