Incentive Provision and Optimal Team Size for Managing Innovation

Abstract

This paper analyzes a principal-agent-model with a principal, a manager, and a team of workers to investigate the incentive provision and optimal team size in a setting with uncertain productivity and team synergy effects which is typical for innovation environments. Workers are responsible for providing productive effort, whereas the manager performs monitoring and productivity risk-reducing efforts. We find that the incentive provision for productive and monitoring effort take the uncertain productivity into account, whereas the incentive provision for the productivity risk-reducing effort is independent of the risk level and the productivity. Furthermore, we find that the optimal team size depends on environmental factors and team effects, specifically, that increasing productivity risk requires smaller teams. Consequently, increasing project risk should be countervailed by downsizing the project instead of managing the risk. The interdependence between team size and incentive provision implies that organizational design and incentive design need to be optimized simultaneously.

Keywords: Incentive Contracts, Uncertainty, Team Size, Innovation

JEL Classification: L22, M41, M52, O32