Performance incentives and the dynamics of voluntary cooperation (mimeograph

How reversible are incentive systems? – Can firms revert to “trust and reciprocity ” after practicing “pay for performance”? – These questions highlight the motivation underlying our work here. It is fashionable nowadays for firms to establish performance based pay systems. There seems to be a common understanding among business people that incentive contracts are essential in order to get employees to well-behave. This view is in line with the purely economic view of man, but it is challenged by the idea that monetary incentives may crowd out intrinsic motivation, an idea that has been put forward by social psychologists and, more recently, a few economists. Intrinsic motivation of employees can not be directly observed. However it has been shown in laboratory experiments on principal-agent games that economic efforts of participants may be well above the levels that are economically rational. Thus, there is over-provision of effort by agents, which may be seen as indirect evidence of intrinsic motivation and which we refer to as “voluntary cooperation”. We replicate and extend this line of research by investigating whether voluntary cooperation is affected by incentive contracting in the short run and in the long run. Our main question is whether voluntary cooperation can be re-established after experiencing incentive pay for some time. We find that voluntary cooperation is much smaller after experiencing incentive pay and refer to this effect as crowding out in a dynamic sense. Furthermore, the positive correlation between payment and voluntary cooperation, which can be interpreted as reciprocity, deteriorates. The observed effects are stronger for fine contracts than for bonus contracts