Team Incentives and the Free Rider Problem


Team incentives, where an individual’s compensation is based on the team’s performance, are notoriously difficult to implement. Yet more and more work in companies large and small is being done through formal or informal teams. What do we need to know in order to design better team incentives?

Standard economic theory is a good place to start (though it will not provide all the answers). Economic theory assumes that people prefer leisure to work and are self-interested. Team incentives therefore fall victim to the “free rider” problem.

If all team members are rewarded for the team’s output, then there is little incentive for a self-interested, leisure-seeker to contribute toward the team goals. Since the “shirker” cannot be excluded from the reward, he becomes a free rider – enjoying the rewards without adding any effort. Game theory predicts that all team members look around and decide that their best strategy is not to work either, so the team ends up not working at all. The group incentive has led to a completely undesirable result.

Of course, this is a rather extreme portrayal, but it drives home the point and illustrates why any good compensation professional will tell you “be careful what you pay for.” There are a few ways of dealing with the free rider problem.

The simplest solution is to introduce a way of monitoring effort so that you share in the reward only if there is evidence that you have worked hard enough or well enough. This is what performance management is all about. The monitoring can be done by the firm (e.g., the manager) or by other members of the team. The latter is only practical if the team is small and each member’s effort is observable and measurable.

The situation can be saved if there is repeated interaction among the team members. If there are multiple opportunities for the team to work together for a reward in the future, then team members will be more likely to co-operate in the current project and work.  If they don’t, they may lose future earning opportunities. There may be reputational consequences for poor individual effort. This works out well if teams are formal (i.e., not ad hoc and one-time) and long-lived.

Another dimension to this is if there are social sanctions available. Groups that work together might also “play” together – i.e., have relationships beyond the confines of the team situation. Members can put pressure on team-mates to shape up or ship out.

When team members are close-knit, they internalize each others’ welfare. This builds a positive, co-operative, stable equilibrium. This approach jibes with Jon Katzenbach’s observation of high-performing teams (what he calls “real teams”): that team members become invested in each others’ development and well-being.

Given the above discussion, we can say that the factors that influence whether team incentives will work or not include team longevity, size and composition.

The longer a team stays together, the more powerful the measures of peer pressure, social sanction and internalized welfare.

The larger the team gets, the less members are able to monitor each other, reach a collusive equilibrium, exert social sanctions or internalize each others’ welfare. Other, external factors will play a more prominent role. Also, there will be fewer opportunities to measure relative performance since there will be fewer similar teams for comparison.

Team composition is an important factor. Allowing teams to form autonomously has risks: the team may play well internally but may not play well with other teams. On the other hand, teams of like-minded individuals who have self-selected into the team knowing who they will be working with are likely to perform better. Heterogeneity in team composition is a good thing and is supported by Katzenbach’s notion of complementary skills.

So what is to be done with respect to team incentives? You clearly have to be very careful to avoid the free rider problem. Ownership can play a large role, as can other ways to build and sustain high commitment to a team’s objectives. Even though everyone is not the perfectly rational economic agent that economic theory assumes, you still need to model the game-theoretic or strategic outcomes in order to thwart team members’ efforts at “gaming” the team incentive

Katzenbach’s work on teams is outstanding and serves as a firm basis for exploring team incentives. The literature on team incentives is quite thin. Is anyone interested in doing the hard work on this tough subject with me? Do you have any data on teams and team incentives that we could examine for insights?

 

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About thenelsontouch

Amit is the founder and managing director of Nelson Touch Consulting, a management consultancy that specializes in maximizing the return on human capital through strategy, incentives and analytics.
This entry was posted in Compensation, Incentives, Organization Design, Strategy and tagged , , , , . Bookmark the permalink.

9 Responses to Team Incentives and the Free Rider Problem

  1. An Op-Ed by David Brooks in today’s (March 18, 2011) New York Times offers some evidence that group incentives work in certain situations:

    Susan Helper, Morris Kleiner and Yingchun Wang provide examples of team incentives working in manufacturing settings an NBER (National Bureau of Economic Research) working paper. They compared compensation schemes in different manufacturing settings and found that in some circumstances, group incentive pay and hourly pay motivate workers more effectively than individual incentive pay.

    Joachim Huffmeier and Guido Hertel report results in a study in the Journal of Experimental Social Psychology, based on their analysis of relay swim teams in the 2008 Summer Olympics. They found that swimmers on the first legs of a relay did about as well as they did when swimming in individual events. Swimmers on the later legs outperformed their individual event times. They felt a greater motivation for the team, being indispensable at that stage of the competition.

    See the full article at http://www.nytimes.com/2011/03/18/opinion/18brooks.html?

  2. Here’s another result that speaks to one of the points made in the post. Bandiera, Barankay and Rasul (2010) in an article entitled “Team Incentives: Evidence from Firm Level Experiments” show that workers reduce free-riding within teams by forming teams that include friends. See the full article here: http://www.management.wharton.upenn.edu/barankay/Documents/teams.pdf

  3. Pushpendu Roy says:

    Dear Amit,

    I agree with the fact that others make the free rider pull up his/her socks so that the team’s performance and its incentives are not impacted. This I believe is Peer Monitoring.

    I had conducted a study on Self help Groups in villages in Jharkhand, India. The women there pooled savings and helped each other in times of need. However, the drawee had to return the money with interest later according to the understanding that she had with the group. When she was not able/willing to the group members forced her to work with them in the farms so that she could earn enough and pay up the loan in due course of time.

    A similar mechanism of peer monitoring works in Grameen Bank in Bangladesh. However I do not have a detailed account of that right now.

    Thanks

    • Pushpendu, thanks for your comments. Your example is a textbook instance of peer monitoring. It’s a well-documented phenomenon, especially in the area of micro-finance. I am helping a friend think through a workplace loan model here in the US that would be the basis for an employee benefit (i.e., small loans) provided at arm’s length from the employer by a vendor. The employee is responsible for repayment, not the employer and so we are thinking of ways we can use peer monitoring to improve the likelihood of timely and full repayment.

  4. ccc says:

    your words are very useful for me to write my homework 🙂

  5. I do not even understand how I ended up right here, but I thought this submission is great. I do not know who you are. However, you are definitely going to a famous blogger. Cheers!

  6. Stefan Bergsten says:

    Dear Mr. Nelson, the Free-rider issue is a critical topic. In the line of sports I think the individual motivation of “pulling” up the average is greater then in real life. In the situation of the swimmers is not just your team members that are doing the monitoring but also the spectators. In this case you have a dual force, there’s not just an upside but also a downside that is obvious to everyone. Maybe the extra effort in the later stage of the relay is purely egocentric of being the ONE that pulled it off….I think that the purpose of the high performance team is that the output is larger then then sum of the individual components. Thats why Katzenbach identified purpose, complementary skills, commitment and accountability as defining characteristics. A high performance team is not neccessary in all situations. But I think its crucial that the team writes its own “contract” that can deal with the Free rider issue. A Rules and Roles of the Game…

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