The Welfare Effects of Incentive Schemes

33 Pages Posted: 21 May 2003

See all articles by Adam M. Copeland

Adam M. Copeland

Federal Reserve Bank of New York

Cyril Monnet

Federal Reserve Bank of Philadelphia

Date Written: February 2003

Abstract

This paper computes the change in welfare associated with the introduction of incentives. Specifically, we calculate by how much the welfare gains of increased output due to incentives outweigh workers' disutility from increased effort. We accomplish this by studying the use of incentives by a firm in the check-clearing industry. Using this firm's production records, we model and estimate the worker's dynamic effort decision problem. We find that the firm's incentive scheme has a large effect on productivity, raising it by 14% over the sample period. Using our parameter estimates, we show that the cost of increased effort due to incentives is equal to the dollar value of a 9% rise in productivity. Welfare is measured as the output produced minus the cost of effort, hence the net increase in welfare due to the introduction of the firm's bonus plan is 5%. Under a first-best scheme, we find that the net increase in welfare is 6%.

Keywords: principal-agent theory, personnel economics

JEL Classification: D61, J3, L2

Suggested Citation

Copeland, Adam M. and Monnet, Cyril, The Welfare Effects of Incentive Schemes (February 2003). Available at SSRN: https://ssrn.com/abstract=386941 or http://dx.doi.org/10.2139/ssrn.386941

Adam M. Copeland (Contact Author)

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

Cyril Monnet

Federal Reserve Bank of Philadelphia ( email )

Ten Independence Mall
Philadelphia, PA 19106-1574
United States

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