Managerial Economics and Organizational Architecture, 5e Managerial Economics and Organizational Architecture, 5e Chapter 16: Individual Performance Evaluation McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc All Rights Reserved Managerial Economics and Organizational Architecture, 5e Performance Evaluation • Evaluations provide employees feedback on achievement and ways to improve • Evaluations are used to determine rewards and sanctions • Performance evaluation entail evaluating employees as well as subunit of the firm 16-2 Managerial Economics and Organizational Architecture, 5e Incentive Compensation Again • Principal-agent model – Employee output: Q = e + objective performance measure – Compensation: W = W0 + Q compensating differential 16-3 Managerial Economics and Organizational Architecture, 5e Implicit Assumptions • Principal knows agent’s production function • Output is single quantitative measure of performance • Output can be observed at zero cost • Employee cannot game the measure • Employee produces a single output • Mutually beneficial contract is feasible • Employee works independently 16-4 Managerial Economics and Organizational Architecture, 5e Setting Performance Benchmarks • Time and motion studies – Engineers estimate the amount of time a task requires – Determines most effective work method • Past performance and ratchet effect – Employees have incentives to only meet the goal and not exceed it 16-5 Managerial Economics and Organizational Architecture, 5e Measurement Costs • Accounting system may need to be developed • Information systems improved • Value-maximizing firm improves measures as long as incremental benefits justify costs 16-6 Managerial Economics and Organizational Architecture, 5e Opportunism • Gaming – Employees may engage in dysfunctional activities to improve their evaluations • Horizon problem – Short-run objective performance measure may cause employees to focus on results that influence their evaluation only over their remaining time with the firm 16-7 Managerial Economics and Organizational Architecture, 5e Relative Performance Evaluation • Evaluate worker output relative to their coworkers in the same job • Within the firm – jobs not always identical – group has incentive to punish “rate busters” – incentive to hire less competent workers • Across firms – data hard to obtain 16-8 Managerial Economics and Organizational Architecture, 5e Subjective Performance Evaluation • Firms often use subjective evaluation along with objective measures • Multiple tasks and unbalanced effort – Workers have incentives to concentrate on activities that are easily measured – The subjective measure will allow the supervisor to determine cooperation and other difficult to measure activities 16-9 Managerial Economics and Organizational Architecture, 5e Subjective Evaluation Methods • Standard rating scales – Rank employees on various performance factors • Goal-based systems – Set annual goals and then measure whether the employee achieved them • Frequency – Often more frequent reviews are too costly – May be beneficial with new hires 16-10 Managerial Economics and Organizational Architecture, 5e Problems with Subjective Evaluations • Supervisor shirking • Forced distribution – May result in good employees being evaluated poorly • Influence costs • Reneging 16-11 Managerial Economics and Organizational Architecture, 5e Combining Performance Measures • Few job performance measures are purely objective or subjective • Both types can be inaccurate – increasing inaccuracy of either places greater weight on other – inaccuracies increase employee risk • Both can induce dysfunctional behaviors 16-12 Managerial Economics and Organizational Architecture, 5e Team Performance • Team production – Individual output: Qi = 5e + – Team output: Qt = 4e2 + – Team value added: E(Qt) > 2E(Qi) when e>2.5 • Team evaluation – peer evaluations to alleviate free-rider problems 16-13 Managerial Economics and Organizational Architecture, 5e Comparing Individual and Team Output Q Conrad and Dina’s team output Expected output Sum of Conrad’s and Dina’s individual outputs 25 e 2.5 Conrad’s and Dina’s individual effort levels 16-14 Managerial Economics and Organizational Architecture, 5e Government Regulation of Labor Markets • Anti-discrimination regulations dictate clear performance evaluation systems • May be inconsistent with value maximization 16-15 ... free-rider problems 16-13 Managerial Economics and Organizational Architecture, 5e Comparing Individual and Team Output Q Conrad and Dina’s team output Expected output Sum of Conrad’s and Dina’s individual... supervisor to determine cooperation and other difficult to measure activities 16-9 Managerial Economics and Organizational Architecture, 5e Subjective Evaluation Methods • Standard rating scales – Rank... method • Past performance and ratchet effect – Employees have incentives to only meet the goal and not exceed it 16-5 Managerial Economics and Organizational Architecture, 5e Measurement Costs •