Performance Metrics for Collaborative and Cross-Functional Teams

Abstract:     
Performance metrics support the objectives of the organization by inducing employees to execute specific tasks and projects. Within certain contexts, such as innovation, projects require cross-functional teams whose members perform specialized tasks that exhibit complementarities and yield uncertain outcomes. The choice of the "right'' performance metric for these teams is challenging. We explore a basic trade-off between two widely used forms of performance metrics: functional and team-based. Whereas functional metrics assess an individual's effort more precisely (less noisy approximation of true effort commitment), they fail to capture any complementarities. In contrast, team-based metrics induce team members to account for complementarities at the expense of a less precise estimate of individual effort. We build a principal-(multi)agent economic model to analyze such an organizational setting. We compare the resulting profit of the firm under either form of metric, when an optimal incentive is employed. Through this comparison we determine which performance metric is appropriate given the characteristics of the initiative. The optimal choice of metric depends on the level of risk that is associated with functional tasks and the complementarity between them. Riskier initiatives prompt the use of team-based metrics, whereas when the project exhibits a high degree of functional complementarity the organization benefits more from functional metrics. Moreover, the choice of metrics is contingent on the composition of team capabilities; disparate execution capabilities between the team-members favor the use of functional metrics, because they allow senior management to leverage the highly capable function.

Number of Pages in PDF File: 34

Keywords: Incentive Design, Team Compensation, Cross-functional Teams, Performance Metrics

JEL Classification: D23, J33, M52, M54, O31, O32

working papers series