Problem Set 5

Due 4/7/97


1. Nicholson Problems 11.8, 12.8, 13.10, 15.6, 9.4, 9.6.


1. Consider the Salomon Brothers performance-pay system described in the article "Does Organization Matter" by Milgrom and Roberts.

(a) What factors should companies take into account when determining how much of pay to tie to performance? First describe the factors according to the model analyzed in class, and then propose two additional factors which might be important.

(b) According to your answer in part (a), does Salomon's scheme seem reasonably well suited for its activities? What other jobs can you think of where similar schemes might be appropriate? Where performance pay wouldn't make sense?

(c) What kinds of individuals (in terms of characteristics of their utility functions) would find Salomon's scheme most appealing? Do you think that this is the kind of individual Salomon wants to attract?

2. Sometimes incentive systems can have unintended consequences.

(a) What was the downside of Salomon's incentive scheme (see the article as well as the question at the end of the chapter).

(b) What does the Soviet experience tell us about the effectiveness of using quantity targets alone?

(c) Incentives are not always explicit. Under their first system, what were the implicit incentives of Hudson Bay workers to communicate information about local conditions to headquarters in London?