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The Effect of Performance-Based Incentive Contracts on System 1 and System 2 Processing in Affective Decision Contexts: fMRI and Behavioral Evidence

55 Pages Posted: 18 Jul 2012 Last revised: 10 Jun 2014

Anne M. Farrell

Miami University Farmer School of Business - Department of Accountancy

Joshua O. Goh

National Institutes on Aging

Brian J. White

University of Texas at Austin - Department of Accounting

Date Written: June 9, 2014

Abstract

Managers may rely on emotional reactions to a setting to the detriment of economic considerations (“System 1 processing”), resulting in decisions that are costly for firms. While economic theory prescribes performance-based incentives to align goals and induce effort, psychology theory suggests that the salience of emotions is difficult to overcome without also inducing more deliberate consideration of both emotional and economic factors (“System 2 processing”). We link these perspectives by investigating whether performance-based incentives mitigate the costly influence of emotion by inducing more System 2 processing. Using functional magnetic resonance imaging and traditional experiments, we investigate managers’ brain activity and choices under fixed wage and performance-based contracts. Under both, brain regions associated with System 1 processing are more active when emotion is present. Relative to fixed wage contracts, performance-based contracts induce System 2 processing in emotional contexts beyond that observed absent emotion, and decrease the proportion of economically costly choices.

Keywords: Performance-based incentives, affect, dual process models, knowledge accessibility, System 1 and System 2 processing, fMRI

Suggested Citation

Farrell, Anne M. and Goh, Joshua O. and White, Brian J., The Effect of Performance-Based Incentive Contracts on System 1 and System 2 Processing in Affective Decision Contexts: fMRI and Behavioral Evidence (June 9, 2014). Accounting Review, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2111452 or http://dx.doi.org/10.2139/ssrn.2111452

Anne M. Farrell

Miami University Farmer School of Business - Department of Accountancy ( email )

800 East High Street
3094 Department of Accountancy / MSC 1002
Oxford, OH 45056
United States

Joshua O. Goh

National Institutes on Aging ( email )

Bethesda, MD 20892
United States

Brian J. White (Contact Author)

University of Texas at Austin - Department of Accounting ( email )

Austin, TX 78712
United States

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