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Relative Thinking and Task Performance: Does a Larger Fixed Payment Reduce the Perceived Magnitude of the Pay-For-Performance Component?

Publication Date:
Jan 2007
Project Programs:
Behavioral Economics

Many previous experiments suggest that people exhibit "relative thinking": they often consider relative price differences even when only absolute price differences should matter. The article reports the results of an experiment that tests whether relative thinking exists in a context never explored before, of task performance with mixed compensation schemes that include both fixed and pay-for-performance components. Such compensation schemes are prevalent in many occupations (for example salespeople and managers) and therefore the article addresses an important practical issue. Surprisingly, relative thinking disappears in this context: the ratio between the pay-for-performance compensation and the fixed compensation does not affect effort. To test whether the different context or the introduction of financial incentives (which were not used in previous studies of relative thinking) is the reason that relative thinking disappears, a hypothetical condition where subjects make similar decisions but without incentives was run. Relative thinking was not documented, suggesting that in the context of task performance people do not exhibit relative thinking regardless of financial incentives. The article therefore contributes both to the literature on relative thinking and to the area of personnel
economics and designing incentive schemes in firms.

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