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The Effects of State Risk and Controllability Filters on Compensation Contract and Effort Choice
Author(s) -
SHIELDS MICHAEL D.,
CHOW CHEE W.,
WHITTINGTON O. RAY
Publication year - 1989
Publication title -
abacus
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.632
H-Index - 45
eISSN - 1467-6281
pISSN - 0001-3072
DOI - 10.1111/j.1467-6281.1989.tb00219.x
Subject(s) - controllability , compensation (psychology) , adverse selection , actuarial science , selection (genetic algorithm) , filter (signal processing) , business , preference , state (computer science) , control theory (sociology) , control (management) , microeconomics , economics , computer science , mathematics , psychology , social psychology , management , artificial intelligence , computer vision , algorithm
Surveys of business firms in the U.S.A. indicate that standard‐based compensation contracts are common in practice. Analytical studies of this form of contract have suggested that under conditions of state risk, an employee's contract and effort choice are significantly affected by how pay relates to measured performance, and whether the compensation contract filters out the effects on measured performance of factors beyond the employee's control. This paper reports the results of a laboratory experiment indicating that in the presence of state risk, an individual's choice of compensation contract depends jointly on these two contract attributes and his/her risk preference as well as performance capability. The findings also indicate that actual effort is a function of the realized state, the presence/absence of a controllability filter, and the level at which the individual had expected to perform at the time of his/her contract selection. When an adverse state was realized, subjects without a controllability filter still exerted the level of effort that they had expected at contract selection, even though their marginal return to effort had been substantially reduced. On the other hand, when the controllability filter was absent, subjects who had a favourable realized state increased their effort in response to the increased marginal return to effort.