Can pay for performance provide the wrong incentives?

The use of technology to improve productivity continues to evolve. In Modern Times, Tramp had to keep up with the crazy pace of the assembly line; in contemporary public administrations, employees have to comply with what is mandated by monitoring and reporting technologies; in today’s World Bank — I’m exaggerating a bit — we are asked to record everything we do in the multiple Bank systems. A legitimate question to ask is whether the reliance on monitoring and reporting technologies improves service delivery or, instead, whether it forces motivated civil servants or employees to waste time “feeding the beast”.
To understand how monitoring and reporting technologies–such as e-government projects aimed at increasing the transparency and accountability of public sector organizations–can improve the quality of public service delivery, in a recent a paper we provide a fresh look at how such technologies can enable Pay for Performance (PFP) contracts, that is, contracts in which compensation depends upon the measured quality of outcomes (made possible by monitoring and reporting technologies). Starting from the premise that measurement of public sector organizations’ outcomes is costly, and that civil servants care about citizens’ satisfaction but only to a certain extent, we discuss when it is optimal to rely on PFP contracts, when it is not, how such contracts should be designed, and what is gained by investing in monitoring and reporting technologies.

One lesson we draw from our analysis is that organizations should consider introducing a monitoring and reporting technology only if it does not impose too high of a burden on the employees, and/or if employees are not sufficiently motivated. We also show that, if there are more and less motivated employees, an effective way to sort them is to offer them different contract options designed in a way that the less motivated employees opt for pay for performance schemes, while the more motivated ones opt for old-fashioned contracts, with lower pay but no reporting requirements.

Two examples help us understand the kind of situations we have in mind. First consider a hospital director who wants to improve the quality of patients’ care that depends on the number of hours doctors work and on the quality of the care they provide, among other things. It is easy to observe the number of hours that doctors work, but immediately assessing the quality of their care is not. In order to improve doctors’ incentives to provide better care, the director may consider linking their compensation not only to the hours they spend in the hospital, but also to the quality of the care they provide. Since the latter is not directly measurable, the hospital can set up a costly monitoring and reporting system, which requires doctors to report how they take care of each patient, and make part of the doctors’ pay linked to the quality of the these reports. Of course, filling a detailed report detracts precious time from actual patients’ care. This means that the decision of whether to adopt a PFP contract (and how to design it) should carefully weigh costs and benefits.

Similarly, consider the case of a school principal who cares about students’ learning, which depends on the number of hours kids are taught and on the quality of teaching. As before, assume that hours are observable, but the quality (of teaching) is not. In order to improve teachers’ incentives to teach well, the principal may consider linking teachers’ compensation to the results of a proficiency test that students are asked to take. Since the results of such a test are an imperfect measure of what kids have actually learned at school, and the preparation of such tests is costly (in terms of hours subtracted from actual teaching), we are again in the presence of trade-offs.

Clearly, the more doctors are committed to patients’ care or the more teachers are committed to education, the higher is the opportunity cost of having them spend time filling reports or preparing for the tests.  An additional, important cost is the one associated with the possibility that the more committed professionals may consider leaving workplaces where too much effort is devoted to costly performance measurement. This may explain why US private schools, where there is no testing, may not only attract highly qualified teachers, but can also pay them lower wages than public schools where test preparation is becoming an increasing burden.  In other words, the fact that more motivated professionals are ready to accept pay cuts to avoid “feeding the monitoring beast” implies that PFP may induce adverse selection.

The fact that the decision of whether to adopt–and how subsequently to design–PFP contracts depends on the interaction between employees’ motivations and the quality of the available monitoring and reporting technology should warn against one-size-fits-all solutions. More precisely, managerial and technological solutions that allow measuring the effort of poorly motivated employees at a reasonable cost, and paying them accordingly, are definitely part of the solution, as New Public Management (NPM) advocates argue. However, these solutions become part of the problem when the contribution of the different tasks to the creation of value is difficult to measure and/or when employees are committed to the goals of the organization (and thus already have incentives to work hard).

Our findings can also help explain the mixed results associated with NPM reforms and e-government initiatives, and call for a more critical approach to the adoption of monitoring and reporting technologies. Reformers should pay at least as much attention to employees’ commitment to public service delivery as to the “measurability” of their daily activities.

This article is published in collaboration with The World Banks Future Development Blog. Publication does not imply endorsement of views by the World Economic Forum.

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Author: Tito Cordella is an Adviser in the Office of the Chief Economist at the World Bank. Antonio Cordella is a Lecturer at the London School of Economics and Political Science.

Image: A stockbroker looks at stock index numbers on his computer screen at a brokerage firm in Mumbai August 6, 2007. REUTERS/Punit Paranjpe.