Knowledge that Transforms

Do multidivisional firms structure compensation contracts for division managers to mitigate incentive problems in their internal capital markets? I find evidence that compensation and investment incentives are substitutes: firms providing a stronger link to firm performance in incentive compensation for division managers also provide weaker investment incentives through the capital budgeting process. Specifically, as the proportion of incentive pay for division managers that is based on firm performance increases, division investment is less responsive to division profitability. These findings are generally consistent with a model of influence activities by division managers in interdivisional capital allocation decisions.

This study uses a model of comparative advantage to model the choice of workers into three broad occupations. The pursuit of comparative advantage is shown to reduce the level of inequality from what would occur in a random assignment of workers into occupations. However, after pricing the skills of workers separately within occupations, the results indicate that the sectors are becoming more similar in the way that they value workers' skills, thus reducing the importance of comparative advantage over time. Inequality is rising as the economy is increasingly characterized by the pursuit of absolute advantage rather than comparative advantage.

This study examines the determinants of performance measure choices in worker incentive plans. The results indicate that informativeness issues such as those addressed in economic theories have a significant effect on measurement choices. However, other reasons for adopting the plans, such as upgrading the workforce and linking bonuses to the firm’s ability to pay, also influence measurement choices, as do union representation and management participation in plan design. Moreover, the factors influencing the use of specific measures vary, suggesting that the aggregate performance measure classifications commonly used in compensation research provide somewhat misleading inferences regarding performance measurement choices.

Home‐based work differs from other employment because the work site is the home itself. This difference means that the fixed costs of working at home are less than the fixed costs of working on site and that home‐based workers may engage in joint market and household production. Using data from the 1990 Census, we find that home‐based work is an attractive option for women for whom the fixed costs of work are high—women who have small children, are disabled, or live in rural areas—and that home‐based workers are more likely to choose self‐employment than are on‐site workers.

This study explores corporate responses to 1993 legislation that capped the corporate tax deductibility of top management compensation not qualified as “performance‐based.” Our analysis suggests that the cap may have created a focal point for salary compensation but had little effect on total compensation levels or growth rates at firms likely to be affected by the limit. There is little evidence that the policy significantly increased the performance sensitivity of chief executive officer (CEO) pay at affected firms. We conclude that corporate pay decisions have been relatively insulated from this policy intervention.

Theoretical models of self‐employment posit that attitudes toward risk, entrepreneurial ability, and preferences for autonomy are central to the individual's decision between self‐employment and wage/salary work. I provide indirect evidence on this hypothesis by examining the relationship between drug dealing as a youth and legitimate self‐employment in later years using data from the National Longitudinal Survey of Youth. I find that drug dealers are 11%–21% more likely to choose self‐employment than non‐drug‐dealers, all else equal. After ruling out a few alternative explanations, I interpret these results as providing indirect evidence supporting the hypothesis.

We investigate how changes in the commitment power of a principal affect cooperation among agents who work in a team. When the principal and her agents are symmetrically uncertain about the agents’ innate abilities, workers have career concerns. Then, unless the principal can commit herself to long‐term wage contracts, an implicit sabotage incentive emerges. Agents become reluctant to help their teammates. Anticipating this risk, and in order to induce the desired level of cooperation, the principal offers more collectively oriented incentive schemes. Temporary workers, though, are not affected by the sabotage effect, and their incentives are more individually oriented.

Empirical work testing for a trade‐off between risk and incentives has had, at best, mixed success. This article provides two simple reasons, associated with subjectivity of performance appraisals, why we might not expect to see any negative relationship. Both reasons relate to empirically observed problems associated with monitoring: (i) supervisors sometimes bias their evaluations based on their personal feelings toward their subordinates, and (ii) supervisors will sometimes offer evaluations that reduce their costs. These aspects of monitoring are ignored in the standard model and can reverse the usual negative trade‐off between risk and incentives.

The focus of tournament models has been rank‐order compensation schemes whereby participants receive higher payments for higher relative performance, either incrementally or winner‐takes‐all. Our research focuses on a unique tournament that offers rewards for both winning and losing, specifically the National Basketball Association’s regularly scheduled season of games. We examine three NBA seasons to determine whether team performance responded to changes in the underlying tournament incentives provided by the NBA’s introduction and restructuring of the lottery system to determine draft order. Our results yield strong evidence that NBA teams are more likely to lose when incentives to lose are present.

Compensating wage theory predicts that workers receiving more generous fringe benefits are paid a lower wage than comparable workers who prefer fewer fringe benefits. This study tests this prediction for employer‐provided health insurance by modeling the wages of married women employed full‐time in the labor market. Husband's union status, husband's firm size, and husband's health coverage through his job are used as instruments for his wife's own employer health insurance benefits. The estimates suggest wives with own employer health insurance accept a wage about 20% lower than what they would have received working in a job without benefits.