Effort and Selection Effects of Incentive Contracts

We show that the improved effort of employees associated with incentive contracts depends on the properties of the performance measures used in the contract.We also find that the power of incentives in the contract is only indirectly related to any improved employee effort.High powered incentive increase the selection effect of the incentive contract and attract better employees to the firm.The selection effect of the incentive contract depends, in turn, on the (perceived) properties of the performance measures specified in the contract.These results hold after controlling for an array of incentive contract design characteristics and for differences in organizational context.Data is from a third party survey on compensation practices among Chief Executive Officers.Our estimation procedures address several known problems with using secondary datasets.