Incentives, Risk , and Information: Notes Towards a Theory of Hierarchy

This paper analyzes the role of incentives, risk, and information in determining the structure of employment contracts. In particular, we focus on the functions performed by piece rate versus time rate payment systems and by supervisors. The relative reliance on piece rates versus time rates is related to risk sharing, to the use of the payment system as a method of screening employees, and to differential information concerning the difficulties of the tasks being performed. The choice of payment system thus depends on the attitudes toward risk of workers and employers, effort supply elasticities, the sources and magnitude of the uncertainties, and the nature of the supervision used in the employment relation. The supervisor is viewed as monitoring inputs (enforcing contracts), screening individuals, obtaining information about the state of the world, etc. These roles are related to the nonconvexities associated with information.