Journal Article

The Welfare Effects of Incentive Schemes

Adam Copeland and Cyril Monnet

in The Review of Economic Studies

Published on behalf of Review of Economic Studies Ltd

Volume 76, issue 1, pages 93-113
Published in print January 2009 | ISSN: 0034-6527
Published online January 2009 | e-ISSN: 1467-937X | DOI: http://dx.doi.org/10.1111/j.1467-937X.2008.00513.x
The Welfare Effects of Incentive Schemes

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  • Demand and Supply of Labour
  • Wages, Compensation, and Labour Costs
  • Human Resource Management

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This paper computes the change in welfare associated with the introduction of incentives. 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 12% over the sample period for the average worker. Using our parameter estimates, we show that the cost of increased effort due to incentives is equal to the dollar value of a 5% rise in productivity. Welfare is measured as the output produced minus the cost of effort; hence, the net increase in the average worker's welfare due to the introduction of the firm's bonus plan is 7%. Under a first-best scheme, we find that the net increase in welfare is 9%.

Keywords: J24; J32; J33; M12

Journal Article.  10459 words.  Illustrated.

Subjects: Demand and Supply of Labour ; Wages, Compensation, and Labour Costs ; Human Resource Management

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