A company manager needs to design performance review systems for two different roles. The first role is a factory worker on an assembly line, where the number of units produced per hour is easily counted and is almost entirely dependent on the worker's speed and attention. The second role is a research scientist trying to develop a new drug, where a breakthrough could take months or years and is subject to many unforeseen experimental failures outside the scientist's control. In which scenario is it more challenging for the manager to accurately judge the employee's level of effort based purely on their observed results, and why?

Evaluating Performance Metrics

In a principal-agent relationship, the moral hazard problem is eliminated as long as the agent's final output is perfectly and costlessly observable by the principal.

Designing Effective Incentives

Effort vs. Outcome in Performance Evaluation

A sales manager oversees two employees. Employee A sells a standardized, high-demand product where daily sales figures are a direct reflection of the number of client meetings they conduct. Employee B is tasked with securing large, long-term contracts for a new, complex technology, where success is also influenced by unpredictable market trends and competitor actions. For which employee can the manager more confidently use raw sales outcomes as a primary indicator of effort, and why?

A manager is designing a payment contract for a data entry clerk whose sole job is to accurately transcribe records. The clerk's output (number of records transcribed per hour) is easily measured, and external factors like system downtime or difficult-to-read records are negligible. Given this low-uncertainty environment, which compensation structure most effectively and fairly links the clerk's pay to their effort?

Effectiveness of Performance-Based Pay

Incentive Scheme Design

Match each principal-agent scenario with its most direct implication for performance evaluation and incentive design.