Full Professor, Colorado State University

Incentives for Performance

Control over preferences is the most significant element distinguishing laboratory experiments from other methods of inquiry. It is of paramount importance that one be able to state that between two experiments, individual values either do or do not differ in any significant way. This control can be exercised by using a reward structure and a property right system to induce prescribed monetary value on (abstract) outcomes.

Outcomes must be measured in order to evaluate the performance of the system. Messages must be measured in order to identify agent behavioral modes. To accomplish these objectives, we will draw from Smith's precepts of experimental economics (1982).

When faced with a costless choice between two alternatives, each identical except that one yields more of the reward medium than the other, the alternative that yields more of the reward medium will be chosen. In other words, people prefer more of the reward medium to less, ceteras paribus.

The institution translates the messages into outcomes and these outcomes allow an individual to claim a reward which increases (decreases) in the good (bad) outcomes. In other words, the amount of the reward medium allocated to an individual is tied directly to the individual/group performance. Not all rewards are salient. Many experimentalists pay subjects $3.00 "up front" for agreeing to participate and for arriving on time to the experiment. A second payment, based on the subject's earnings (tied to their experimental outcomes) is made when the subject leaves the laboratory. This second payment is salient, the first is not.

It is sometimes said that the use of currency (as the reward medium) to induce value on abstract outcomes in a laboratory experiment may be an artificial procedure peculiar to experimental methodology and is not the same thing as having "real preferences". Those who raise this question seem not to realize that all economic systems produce forms of intangible property on which value is induced by specifying the rights of the holder to claim money or goods. All financial instruments, including shares, warrant, etc., have value induced upon the instruments by the bundle of rights they convey. An important part of the property right rules of any institution is the specification of the conditions under which intangible goods can be redeemed in terms of other intangibles or commodities. Obviously the reward medium may make a difference, but this is easily studied as a treatment variable by anyone who is haunted by the thought that it is important. To argue that preferences based on cash-induced value are somehow different that home-grown preferences over commodities is also to argue that preferences among intangible instruments in the field are are also somehow different than commodity preferences.

The reward structure dominates any subjective costs (or values) associated with participating in the activities of the experiment. In other words, if a subject has many motivations while making a decision during the experiment, the amount of reward should be high enough to to exclude all other motivations from entering into the decision. An early path-breaking experimental study of the binary choice game by Siegal (1961) systematically varied reward level. The results showed an increase in the proportion of reward maximizing choices when the reward level was increased for a constant task complexity. Further, when the task complexity was increased, holding reward level constant, the proportion of reward maximizing choices was reduced. Note that the level of the reward in order get dominance depends on the subject population; investment bankers would probably need a much higher level of payments than starving undergraduate students.

Each subject in an experiment is given information only on their own payoff alternatives. This makes sense in that in the naturally occurring economy, only the person making the decision knows what that decision is worth to them.

These precepts allow us to study laboratory environments where real agents exchange real messages through real property rights institutions that yield outcomes redeemable in real money.

Smith, V., “Bidding and Auctioning Institutions: Experimental Results”, Bidding and Auctioning for Procurement and Allocation, University Press, New York: New York, 1976, pp. 43-64.
Smith, V., “Microeconomic systems as an Experimental Science”, American Economic Review, 72:923-955, 1982.
Smith, V., “Economics in the Laboratory”, Journal of Economic Perspectives, 8(1):113-131, 1994.

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