Managing Project Selection Through Contract Design

Abstract

A common decision that organizations make is to prioritize and allocate resources to managers of competing new product projects. On successful completion of the projects, organizations often reward their project managers using a standardized incentive plan; that is, they reward the success of all managers equivalently disregarding the differential amount of resources invested in the projects. We develop a theoretical model to explain this puzzling practice. We model the phenomena where the project managers have private information about the quality of their own projects, and can manipulate the signals of project quality that the organization receives during the identification and resource-allocation stage. We show that when the managers have private information about their project types, a standardized incentive plan encourages the manager of a high-quality project to manipulate more and stand out. We argue that a standardized incentive plan is preferred because such a plan leads to more accurate resource allocation, even though a customized incentive plan is more efficient in inducing the implementation effort. We extend the model to consider alternative project evaluation and selection procedures and find the optimality of the standardized incentive plan to be robust.

Keywords: New Product Development, Incentive Mechanisms, Moral Hazard, Managerial Manipulation