Author Abstract
An organization's compensation strategy plays a critical role in motivating workers and attracting high-performing employees. Most of the research linking compensation to strategy relies on the principal-agent model of economics, a model that has been largely unsuccessful in predicting the extent to which companies use performance-based pay. We argue that while agency theory provides a useful framework to analyze strategic compensation, it fails to consider a host of psychological factors that affect employee motivation and attraction. This paper examines how psychological costs from social comparison, overconfidence, and loss aversion reduce the viability of individual performance-based compensation systems and provides a framework that integrates insights from psychology and decision research into the traditional compensation framework of agency theory. The paper also discusses empirical implications and possible theoretical extensions.
Paper Information
- Full Working Paper Text
- Working Paper Publication Date: December 2010
- HBS Working Paper Number: 11-056
- Faculty Unit(s): Negotiation, Organizations & Markets