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Published online by Cambridge University Press: 05 June 2012
As long as we insist on budget-balancing [in our system of incentives] and there are externalities present, we cannot achieve efficiency. Agents can cover improper actions behind the uncertainty concerning who was at fault. Since all agents cannot be penalized sufficiently for a deviation in the outcome, some agent always has an incentive to capitalize on this control deficiency.
Holmstrom (1982)If hierarchies are going to reconcile efficiency, transitivity, and minimal delegation in their decision making, they can do so only by manipulating individual preferences. The piece-rate system discussed in the preceding chapter is one example of an incentive system that attempts to manipulate individual preferences in such a way that crafts persons with specialized skills can be delegated autonomy with regard to many production decisions.
The piece-rate system seems to perform that function only partially, at best. The use of individual incentives of this sort seems only to dramatize and enhance the underlying conflict of interests in hierarchy. Theoretically, there is very good reason for this – the piece-rate system is a vertical manifestation of the Sen paradox within hierarchy. The subordinate chooses how hard to work, and the superior chooses the piece-rate wage – this constitutes sufficient “delegation” to kick off the Sen paradox. As long as individuals have upward sloping supply functions for their individual effort, the resulting game will be inefficient or unstable.
But perhaps the problem with the piece-rate system is the limited nature of the contracts available.
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