Saturday, July 19, 2008

Awards vs. Monetary Compensation

In an article for VoxEU, Bruno Frey and Susanne Neckermann argue that economists concentrate too much on monetary compensation as an incentive mechanism, and spend too little time studying the incentive effects of awards. They argue that the incentive effects of the "social recognition" that comes with winning awards are not fully reflected in monetary compensation:

There are important differences between awards and monetary compensation making it worthwhile to analyze them separately.
I don't think awards and monetary compensation are quite as distinct as the authors would have you believe. The benefits of winning the Pulitzer Prize are not limited to social recognition: after winning the Pulitzer, a journalist can command a higher salary, as other newspapers bid for the services of Pulitzer-winners. If after winning a Pulitzer, a journalist is hired away by another newspaper for a higher salary, that newspaper can translate the added credibility that comes from hiring a Pulitzer-winner into a higher circulation, which of course means higher revenues. In the end, the "social recognition" that comes from winning a Pulitzer winds up being reflected in monetary compensation. I also have to take issue with Frey and Neckermann's statement that:
The material costs of awards may be very low, or even nil, for the donor, but the value to the recipient may be very high.
Internal awards (where the "donor" is the employer) don't require budgetary outlays, but that doesn't mean they're costless. When an employer gives an award like "manager of the year," it increases the recipient's value on the job market. True, it probably won't add that much to the recipient's value on the job market, but if the added value allows the recipient to credibly entertain higher-paying alternatives, the employer would have to increase his salary in order to keep him. The "material cost" of the award would thus be the amount by which the employer had to increase the recipient's salary. And if the award didn't raise the recipient's value on the job market at all, then the incentive effects of the award were likely minimal to begin with (think "participation awards"). I don't think all the incentive effects of awards are reflected in monetary compensation, as asymmetrical information probably prevents some high-incentive awards from being priced into compensation. But for the most part, awards that have legitimate incentive effects are probably fully priced into monetary compensation.

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