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Unexpected costs of performance incentives with production uncertainty: Theory and evidence from a real‐effort laboratory experiment

Year: 2025

Type: article

Abstract: Policy advocates often promote market‐like incentives for publicly provided services like education or healthcare (e.g., Medicare). Evidence for performance incentives in these sectors is mixed, possibly due to production uncertainty represented as uncertainty about the marginal effect of inputs. Using a principal‐agent model, we demonstrate that such uncertainty can lead to inefficiencies in output‐based incentives. The model illustrates how employees favor inputs with lower uncertainty and reduce overall effort. Input‐based incentives might be more effective in such cases. We conduct a real‐effort lab experiment which validates these predictions: participants shift from efficient inputs as uncertainty grows, and reduce overall effort.

Source: Economic Inquiry

DOI: 10.1111/ecin.70021

Authors: Michael S. Kofoed, Aaron Phipps

Institution: University of Tennessee at Knoxville

Language: English

Topic: Experimental Behavioral Economics Studies

Subfield: Economics and Econometrics

Field: Economics, Econometrics and Finance

Domain: Social Sciences

SDG: Decent work and economic growth

Open Access status: green

Funder: Institute of Education Sciences