Comparing Managerial Control and Performance Pay

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...carefully crafted and monitored managerial controls over mechanics led to a 20 percent increase in revenue.

Employers have long used performance pay and managerial controls as ways to boost employee productivity while also trying to avoid shirking and other problematic behavior (moral hazard) of workers. Reducing Moral Hazard in Employment Relationships: Experimental Evidence on Managerial Control and Performance Pay (NBER Working Paper No. 19645), by Kirabo Jackson and Henry Schneider, reports the findings from a field experiment that compared managerial controls and performance pay at an auto repair firm. The authors find that carefully crafted and monitored managerial controls over mechanics led to a 20 percent increase in revenue. The results also suggest that a balanced combination of managerial controls and performance pay had the greatest effect in raising productivity and reducing moral hazard.

The authors explain that performance pay has often received attention from employers, public policymakers, and economists as a means of providing incentives to improve employee performance and behavior. Most Fortune 1000 companies use some form of performance pay to compensate employees and there are increasing calls to adopt performance pay at schools and hospitals. But previous studies have shown that performance pay alone does not always generate the hoped-for outcomes if firms don't effectively observe and supervise workers. This study explores whether managerial controls and performance pay can complement each other in boosting productivity and reducing undesirable worker actions.

The authors worked with a U.S. auto repair chain to design a field experiment with 11 shops in one metropolitan area. The firm provided data on all customers, cars, repairs, and employee pay and hours, and other data covering the 2003-13 period. The authors and management then developed a comprehensive checklist of items on a car that mechanics were required to inspect to determine what repairs might be needed, even if a car was brought in for only an oil change or another simple procedure. Managers closely monitored mechanics to make sure the checklist inspections were handled properly, and the final checklists were routinely collected and maintained by the firm. Some of these same mechanics, many of whom were already compensated by a combination of base pay and commissions, also received commission increases, and the authors tested to see if that led to a higher invoice count and different behavior.

There was an increase in the amount of added repairs and revenue by mechanics under both regimes. The pre-repair checklist inspections led to a 20 percent increase in revenue, a mean increase of $42 per car visit, while a 1 percentage point boost in commission pay for the mechanic led to a mean $29 increase per visit. The managerial-control effect was equivalent to that of a 10 percent increase in the commission rate, suggesting that managerial controls are viable alternatives to performance pay in raising employee productivity and reducing moral hazard. The effect of adopting managerial controls was larger among mechanics who received higher commission rates than among those with lower rates, indicating that managerial controls and performance pay complement each other.

While managerial controls led to increased revenue attributable to more repairs conducted on cars and more work performed per week, mechanics who received boosts in their commission rates often increased revenue to the firm by substituting higher-revenue repairs for lower-revenue ones, without a corresponding increase in work hours or in the number of repairs conducted. The authors raise the possibility that this shift reflected mechanics exploiting their knowledge and informational advantage relative to customers and was not in the customers' best interest.

--Jay Fitzgerald