The Effect of Explanations and Monetary Incentives on Effort Allocation Decisions

Abstract

In this study I examine the joint effect of explanations and monetary incentives on employees' effort allocation decisions in a multi-action setting. A rich literature in economics indicates that monetary incentives substantially influence employees' decisions. This literature demonstrates that the size of the incentive for a given performance measure should consider the measure's sensitivity, congruence and precision. Research in psychology demonstrates the decision influencing effects of explanations (a non-monetary factor) on employees' decisions through perceptions of fairness. I expect that effort allocation decisions are influenced both by explanations and monetary incentives: I hypothesize that providing reasonable and complete explanations substantively alter agents' action choices relative to a setting with monetary incentives alone. Using student subjects in experiments, I find that monetary incentives matter. Moreover, for sizeable monetary incentives, providing a detailed explanation modifies behavior favorably relative to when an unclear explanation is provided. However, for all of the considered monetary incentives, merely requesting a desired course of action is also enough to modify behavior favorably. This study contributes to the accounting literature by providing evidence of a decision influencing benefit associated with the use of explanations such as causal maps employed by firms adopting the balanced scorecard. This study also contributes to the organizational justice literature by (1) providing evidence regarding the interaction effect of multiple antecedents of justice, and (2) by confirming that not providing an explanation for a desired allocation of effort is better than providing a poor explanation. Finally, the results of this study provide empirical support to the analytic literature indicating that monetary incentives used to align goals should consider the precision with which the performance measures capture actual effort allocation.

Keywords: Incentives, performance measure, informational justice, multi-task

JEL Classification: M40, M46, J33