Effects of a group performance-based incentive scheme on labor productivity, product quality, and organizational performance

Abstract

This study uses a field method to examine the effects of a group compensation plan on labor productivity, product quality, and organizational performance, in three independent subunits of the same manufacturing plant. More specifically, the study investigates whether the use of two budget-based incentives, a group output-target based scheme and a gain-sharing scheme offered in combination, motivates production teams to improve economic performance in this manufacturing setting. The output-target based scheme is a linear budget-based incentive that rewards individual team performance, providing a cash bonus when quantity meets or exceeds a target and a low (penalty) wage when quantity or product quality falls short of a target. The gain-sharing scheme (also a budget-based scheme) rewards production teams for achieving plant-level quarterly targets for labor productivity and product quality. After controlling for numerous factors that influence labor productivity and product quality in a multivariate regression model, I find that the combination of incentives schemes is associated with improvements in performance. Labor productivity increases by sixty eight percent and the defects rate decreases by ninety five percent following implementation of the incentive scheme. I also found a reduction in absenteeism and turnover, as well as improvements in the percentage of work orders completed on schedule. Although I cannot attribute the observed performance improvements to a specific scheme, nor discern whether the improvements are causally linked in some proportion to greater worker effort, improved peer monitoring, improved team cooperation, or better strategy development (i.e., worker learning); the empirical results of the study suggest that team (and group) performance is enhanced through the use of standard-based incentives contracts. Moreover, the results suggest that both schemes offered jointly with mechanisms to prevent free-riding and promote worker learning (timely performance feedback) create synergies in this particular setting that motivate production teams to improve performance. These findings suggest that this combination is effective in motivating group effort, promoting cooperation, and encouraging peer monitoring within and across production teams. All these factors leading to improvements of the firm's economic performance.