Compensation and Incentives: Practice vs. Theory

38 Pages Posted: 24 Sep 1998  

George P. Baker

HBS Negotiations, Organizations and Markets Unit; National Bureau of Economic Research (NBER)

Michael C. Jensen

Social Science Electronic Publishing (SSEP), Inc.; Harvard Business School; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

Kevin J. Murphy

University of Southern California - Marshall School of Business; USC Gould School of Law

Abstract

A thorough understanding of internal incentive structures is critical to developing a viable theory of the firm, since these incentives determine to a large extent how individuals inside an organization behave. Many common features of organizational incentive systems are not easily explained by traditional economic theory--including egalitarian pay systems in which compensation is largely independent of performance, the overwhelming use of promotion-based incentive systems, the absence of up-front fees for jobs and effective bonding contracts, and the general reluctance of employers to fire, penalize, or give poor performance evaluations to employees. Typical explanations for these practices offered by behaviorists and practitioners are distinctly uneconomic--focusing on notions such as fairness, equity, morale, trust, social responsibility, and culture. The challenge to economists is to provide viable economic explanations for these practices or to integrate these alternative notions into the traditional economic model.

JEL Classification: G31, G32, J31, J33

Suggested Citation

Baker, George P. and Jensen, Michael C. and Murphy, Kevin J., Compensation and Incentives: Practice vs. Theory. Michael C. Jensen, FOUNDATIONS OF ORGANIZATIONAL STRATEGY, Harvard University Press, 1998; Journal of Finance, Vol. 63, No. 3, pp. 593-616, July 1998. Available at SSRN: https://ssrn.com/abstract=94029 or http://dx.doi.org/10.2139/ssrn.94029

George P. Baker (Contact Author)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

HBS Negotiations, Organizations and Markets Unit ( email )

Soldiers Field
Boston, MA 02163
United States
617-495-6119 (Phone)
617-496-4191 (Fax)

HOME PAGE: http://www.people.hbs.edu/gbaker/index.html

Michael C. Jensen

Social Science Electronic Publishing (SSEP), Inc. ( email )

7858 Sanderling Road
Sarasota, FL 34242
United States
617-510-3363 (Phone)
305 675-3166 (Fax)

HOME PAGE: http://ssrn.com/author=9

Harvard Business School ( email )

Soldiers Field
Negotiations, Organizations & Markets
Boston, MA 02163
United States
617-510-3363 (Phone)
305-675-3166 (Fax)

HOME PAGE: http://drfd.hbs.edu/fit/public/facultyInfo.do?facInfo=ovr&facId=6484

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

European Corporate Governance Institute (ECGI) ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Kevin J. Murphy

University of Southern California - Marshall School of Business ( email )

BRI 308, MC 0804
Los Angeles, CA 90089-0804
United States
213-740-6553 (Phone)
213-740-6650 (Fax)

USC Gould School of Law

699 Exposition Boulevard
Los Angeles, CA 90089
United States

Paper statistics

Downloads
10,451
Rank
265
Abstract Views
36,345