Working Paper | HBS Working Paper Series | 2010

Incentive Schemes, Sorting and Behavioral Biases of Employees: Experimental Evidence

by Ian Larkin and Stephen Leider

Abstract

We investigate how the convexity of a firm's incentives interacts with worker overconfidence to affect sorting decisions and performance. We demonstrate experimentally that overconfident employees are more likely to sort into a non-linear incentive scheme over a linear one, even though this reduces pay for many subjects and despite the presence of clear feedback. Additionally, the linear scheme attracts demotivated, underconfident workers who perform below their ability. Our findings suggest that firms may design incentive schemes that adapt to the behavioral biases of employees to "sort in" ("sort away") attractive (unattractive) employees; such schemes may also reduce a firm's wage bill.

Keywords: Compensation and Benefits; Employees; Retention; Selection and Staffing; Personal Characteristics;

Citation:

Larkin, Ian, and Stephen Leider. "Incentive Schemes, Sorting and Behavioral Biases of Employees: Experimental Evidence." Harvard Business School Working Paper, No. 10–078, March 2010. (Revised September 2011.)