The Optimal Structure of Incentives and Authority within an Organization

TLDR

In many organizations, employees’ abilities are not directly observable. The paper presents two models of productive organizations. The authors analyze a perfect‑observation model where rewards match individual performance, and an imperfect‑observation model that derives optimal payment schedules and organizational structures. They prove that wages equal marginal products in the absence of labor‑market monopsony, and they also analyze the monopsony scenario.

Abstract

Two kinds of models for a productive organization are presented. In the first, both production and rewards are based on the performance of individuals, which is perfectly observed. Their abilities are not observable. Despite this, theorems are proved giving strong grounds for the equality of wages and marginal products unless there is monopsony in the labor market. This latter case is also discussed. The second model, which focuses on the imperfect observation of performance, allows interesting deductions about optimal payment schedules and organizational structure.