The Effect of Imprecise Information on Incentives and Team Production

This paper links the quality (i.e. noise and bias) of information available for production decisions and performance evaluation to the choice of whether or not production should occur in teams. The information system provides agents with access to an early but imprecise signal about productivity and consists of a performance evaluation system that measures agents’ performance with both error and bias. The use of teams depends critically on the presence of an imprecise information system, on the incentive problem, and on whether or not the principal has knowledge of the productivity signal. If the principal can also observe the imprecise signal about productivity, then team production will always be optimally employed because aggregation reduces error in the performance measures, thus reducing the cost of the incentive problem. When the agents privately observe the productivity signal, teams are not always preferred, and the threshold for teamwork, or the level of precision of the agents’ information for which teams are preferred, depends inversely on the amount of measurement error in the performance measure. Further, the impact of a biased performance measurement system depends on the precision of the biased system compared to the unbiased system, and the direction of the bias