Nonlinear Incentive Schemes
Using nonlinear incentives to motivate effort
Nonlinear incentive schemes use a combination of linear and nonlinear payments to motivate effort. They can be effective in situations where linear incentives are not enough to motivate workers.
- Nonlinear incentives can be more effective than linear incentives in motivating effort.
- Nonlinear incentives can be designed to take into account the specific needs and goals of the organization.
- Nonlinear incentives can be used in combination with linear incentives to create a more effective incentive scheme.
- Define the task and the desired outcomeClearly define the task and the desired outcome, and identify the key performance indicators (KPIs) that will be used to measure success.Pro tipMake sure the KPIs are observable and measurable.WarningAvoid using KPIs that are easily manipulable.
- Determine the average payment and the spread of paymentsDetermine the average payment to the worker and the spread of payments in good versus bad outcomes, taking into account the participation constraint and the desired level of effort.Pro tipConsider using a combination of linear and nonlinear payment schemes.WarningBe aware of the potential for manipulation and gaming of the system.
- Design the nonlinear incentive schemeDesign the nonlinear incentive scheme, taking into account the task, the desired outcome, and the average payment and spread of payments. Consider using a carrot or stick approach, or a combination of both.Pro tipMake sure the nonlinear incentive scheme is transparent and easy to understand.WarningAvoid using nonlinear incentive schemes that are too complex or difficult to understand.
- Monitor and adjust the nonlinear incentive schemeMonitor the effectiveness of the nonlinear incentive scheme and adjust it as needed. Consider using data and feedback from workers to identify areas for improvement.Pro tipBe willing to make changes to the nonlinear incentive scheme if it is not working as intended.WarningAvoid making changes to the nonlinear incentive scheme too frequently, as this can create uncertainty and undermine trust.
The salesperson bonus scheme
The salesperson is motivated by a bonus scheme that pays a higher bonus for meeting or exceeding a certain quota.
OutcomeThe salesperson is motivated to sell more, and the company achieves its sales goals.
The CEO compensation scheme
The CEO is motivated by a compensation scheme that includes a combination of salary, stock options, and bonuses tied to performance.
OutcomeThe CEO is motivated to perform well, and the company achieves its goals.
Failing to consider the participation constraint
Failing to consider the participation constraint can lead to a nonlinear incentive scheme that is not effective in motivating workers.
Using observable metrics that are easily manipulable
Using observable metrics that are easily manipulable can lead to gaming of the system and undermine the effectiveness of the nonlinear incentive scheme.
Not considering the potential for manipulation
Not considering the potential for manipulation can lead to a nonlinear incentive scheme that is vulnerable to exploitation.
Nonlinear incentive schemes have been studied by game theorists and economists, who have identified their potential to motivate effort in situations where linear incentives are not effective.
Source · BOOK
The Art of Strategy: A Game Theorist's Guide to Success in Business and Life