How do contract types and incentives influence driver behavior?−An analysis of the Kigali bus network

The rapidly growing city of Kigali has a bus network that is undergoing increased development as underlined in its Transport Master Plan. Two schemes of bus driver remuneration coexist in the city: One constitutes a hybrid salary and commission system, while the other pays a fixed monthly salary. This paper examines the effect of these differing compensation schemes on driver behavior in Kigali using survey data from 2019. The analysis applies linear models incorporating various aspects of driver behavior in a principal-agent framework. The results indicate that the performance-based compensation scheme is associated with higher per-trip passenger fluctuation and faster driving (possibly due to drivers aiming to accrue a higher income) compared to the fixed-wage system. Policy implications comprise the inclusion of further criteria in incentive contracts to internalize potential negative externalities on society, e.g., to hinder the endangerment of passenger safety by appropriately incentivizing drivers. In conclusion, bus drivers who are compensated by performance are more likely to alter their behavior, responding to the incentive scheme through several channels.

The Effect of External Audits: Evidence from Voluntary Audits of Hedge Funds

Using the setting of hedge funds, we document two important merits of external audits. We find that incentive fee rates (i.e., performance-based compensation to fund managers) are higher for audited funds than for unaudited funds. In contrast, management fee rates (i.e., fund-size-based compensation to fund managers) do not differ depending on audit status. We also find some evidence that audited funds attract more capital inflows from investors than unaudited funds do after funds report high performance. Our findings indicate that hedge fund investors appreciate the value of external audits.

The Behavioral Promise and Pitfalls in Compensating Store Managers

Compensation systems have rapidly been shifting away from a fixed wage contractual payment basis. Many companies today are creating incentive compensation contracts to reward hard-working employees for jobs done well. Profit sharing (“sharing compensation contract”) and target with bonus (“target compensation contract”) are two common performance-based compensation contracts prevalent in business. We theoretically and behaviorally study the sharing and target compensation contracts in an operational context where a firm sets the parameters of the compensation contracts and a store manager, after observing the compensation contract offered to him, chooses his effort level (unobservable by the firm) and makes ordering decisions for the store. Our experimental data suggest systematic deviations from the theoretical benchmark and reveal behavioral promise and pitfalls under the two compensation contracts. In particular, the store manager is more willing to exert high effort under the target contract all else being equal. However, the store manager is also more likely to punish the firm for perceived “unfair” offers by submitting an extremely low order quantity. We find that bounded rationality plays an important role in driving a higher effort rate under the target contract than the sharing contract. We introduce a new formulation of the fairness concerns, which is referred to as by-state fairness, where individuals, rather than considering whether the expected profits received are fair, consider the fairness in the potential realized outcomes. This new formulation explains why managers are more likely to order very little to punish the firm under the target contract. In addition, we conduct validation experiments to verify our behavioral explanation. This paper was accepted by Jayashankar Swaminathan, operations management.

In the Nick of Time: Performance-Based Compensation and Proactive Responses to the Tax Cuts and Jobs Act

The Tax Cuts and Jobs Act of 2017 (TCJA) introduced two major changes that may influence executive compensation: (1) reducing corporate tax rates from 35 to 21 percent and (2) eliminating the performance-based pay exception in Section 162(m). These changes provide incentives to maximize deductible compensation expense in 2017, before the TCJA goes into effect. Consistent with our expectation, we find that the increase in CEO bonus and stock option compensation is significantly greater in 2017 relative to prior years. Our difference-in-difference results are consistent with the tax rate reduction driving the bonus increase and the repeal of the performance-based exception leading to the increase in CEO stock options. The TCJA also changed the definition of covered employees to include the CFO. We find weak evidence for abnormal increases in CFO performance-based compensation. Overall, our findings suggest that firms' responded to the TCJA in the period before it was effective.

Determinants of Gender Differences in Change in Pay among Job-Switching Executives

The authors investigate what determines differences in change in pay between men and women executives who move to new employers. Using proprietary data of 2,034 executive placements from a global search firm, the authors observe narrower pay differences between men and women after job moves. The unconditional gap shrinks from 21.5% in the prior employer to 15% in the new employer. After controlling for typical explanatory factors, the residual gap falls by almost 30%, from 8.5% at the prior employer to 6.1% in the new placement. This change reflects a relative increase in performance-based compensation for women and a lower level of unexplained pay inequality generally in external placements. Controlling for individual fixed effects, observed women have higher pay raises than do men. Finally, the authors find suggestive evidence that pay differences may also be moderated by differences in the supply and demand for women executives.

The relationship between CEO compensation and company performance measurements of listed South African firms

Some commentators argue that increased chief executive officer (CEO) compensation may lead to increased company performance, while others argue that increased CEO compensation does not necessarily lead to increased company performance. These different opinions led to several pay-performance studies to identify and analyse the relationship, if any, between CEO compensation and company performance. The motivation for the present study was to determine whether different performance measurements in a pay-performance study would provide different results, as well as to determine whether certain firms’ performance measurements correlate better to compensation than those of other firms. The main finding of the research was that there is a substantial difference in the correlational relationships identified between CEO compensation and company performance, depending on the performance measurement used. In this study earnings per share reported the strongest positive correlation at 0.89 and return on assets reported the strongest negative correlation at  -0.79 to CEO compensation. The findings suggest that researchers should carefully consider what performance measurement to use when conducting pay-performance studies as very different results could be delivered. In addition, stakeholders should take note of the specific performance measurement that they should apply if they want to negotiate a performance-based compensation system.

Using Fixed Wages for Management Control: An Intra-Firm Test of the Effect of Relative Compensation on Performance

ABSTRACT Efficiency wage theory predicts employers can elicit better employee performance ex post by paying higher fixed compensation ex ante, relative to the market wage. Relative compensation may thereby constitute an alternative control mechanism when performance-based compensation is difficult to implement. Using proprietary data from 436 hotels in a U.S. lodging chain, we find that relative compensation is positively associated with performance, and additional profits associated with higher compensation exceed the wage increase. Relative compensation has a larger impact on profit when tasks are more complex and a smaller impact on profit, revenue, and quality when chain monitoring is stronger. Finally, the magnitude of the relation between relative compensation and financial performance (nonfinancial) is larger (the same) for employees earning more than the median wage compared with those earning less. Overall, our results are consistent with assertions that higher relative compensation attracts more capable candidates and mitigates shirking, but provide little support for reciprocity. Data Availability: The confidentiality agreement with the firm that provided data for this study precludes revealing its identity and disseminating data.