Incentive Complexity, Bounded Rationality, and Effort Provision

This paper shows that dynamic incentives embedded in an organization’s workplace incentive scheme can be a shrouded attribute, due to contract complexity and worker bounded rationality. This is true in field experiments within the firm, and in complementary online experiments with real effort tasks. Structural estimates indicate that rational agents who fully understand the incentive scheme would behave sigificantly different from what we observe. A response to dynamic incentives does emerge when we reduce complexity or look at workers with higher cognitive ability. The results illustrate the potential value of complexity to organizations, they demonstrate that complex incentive contracts may allow firms to be achieve better than second-best, they identify specific features of contracts that can influence the effectiveness of incentives through the channel of complexity, and they imply heterogeneous effects of incentives depending on worker cognitive ability.