[This study reports on two experiments examining the effects of alternative incentive pay schemes for controlling unit manager behavior in intrafirm resource allocation settings. Two control problems are addressed: unit managers' misrepresentation of private information to the central manager prior to allocation, and unit managers' consumption rather than investment of resources subsequent to allocation. The experimental setting was adapted from Groves and Loeb (1979). The firm consists of central management and two units. The role of the (mechanized) central manager is to maximize firm profit by acquiring a common resource and allocating it to the units. The central manager also executes a control mechanism consisting of a performance measure and pay function for the unit managers. The role of each unit manager is to send a message to the central manager before the resource is acquired and to generate profit by investing allocated resources in productive activities. Actual unit profit depends on the unit's profit function and invested resources, which are known only to the unit manager. The linear profit function was in the form of a productivity ratio, i.e., the ratio of outputs to inputs. The central manager learns each unit's actual profit when realized. In both experiments, students served as subjects. Experiment 1 focused on unit managers' misrepresentation, which was measured by the difference between projected and actual p-ratios, under three incentive schemes: (1) unit profit scheme-a unit manager's pay is linear in actual unit profit, (2) unit profit-plus-penalty scheme-a unit manager's pay is linear in actual unit profit except that there is a "large" penalty when an unfavorable profit variance occurs, and (3) Groves scheme-a unit manager's pay is linear in the sum of his or her unit's actual profit and the other unit's budgeted profit. As predicted, misrepresentation was higher under the unit profit scheme than under the other schemes. Contrary to prediction, misrepresentation was higher under the Groves scheme than under the unit profit-plus-penalty scheme. The latter result may have been due to either or both of two factors associated with the Groves scheme. First, some subjects may have tried to gain from tacit collusion. Second, some subjects may have failed to understand the scheme's incentives, given noncooperation. Experiment 2 focused on resource consumption, which was measured by inputs exchanged directly for cash rather than invested, under the Groves and unit profit-plus-penalty schemes. As predicted, resource consumption was higher under the Groves scheme than under the unit profit-plus-penalty scheme. This result was largely due to the latter scheme's penalty, which forces a unit manager to invest enough resources to achieve budgeted unit profit.]

Reports on two experiments examining the effects of alternative incentive pay schemes for controlling unit manager behavior in intrafirm resource allocation settings. Resource allocation and the Groves scheme; Operationalization of the resource allocation setting; Cash earning schedule; Unit managers' responses to bonus pay.