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Dynamic Incentives in Organizations: Success and Inertia

Authors

  • Martin Ruckes,

    1. Karlsruhe Institute of Technology
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  • Thomas Rønde

    1. Copenhagen Business School
    2. C.E.P.R., London
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    • We would like to thank Dan Goldstein, Ann Miner, Peter Møllgaard, and participants at seminars at Copenhagen Business School, University of Antwerp, University Carlos III (Madrid), University of Leuven, the Nordic Workshop in Industrial Organization (NORIO IV) and the WZB Conference on ‘Economics and Psychology: Applications to Industrial Organization, Public Finance, and Finance’ for useful comments on earlier drafts. We are particularly grateful for suggestions from an anonymous referee which helped us to improve the paper considerably. Author names are ordered alphabetically (according to the Danish alphabet).

Abstract

We present a two-period model in which an employee searches for business projects in a changing environment. An employee who discovers a profitable project in period 1 is reluctant to search again in period 2 because the old project may continue to be profitable. Management's response to this inertial tendency is either to increase the financial incentives to encourage searching or to accept no searching. The former response increases search efforts and total profits; the latter response has the opposite results. Inertia can be removed by restructuring the firm in period 2, but this may create a time-inconsistency problem.

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