The Reward System

Abstract

The importance of the bonus structure in a public sector dominated economy has been noted by many writers. Since economic reforms in the USSR and many other socialist countries were initiated in the early 1960's, there have been a few studies analyzing the bonus schemes in Soviet-type economies. (See S. Gindin, Michael Ellman, Michael Keren, James A. Mirrlees, and Wayne A. Leeman.) The trend toward profit-related bonus schemes has been continuing in socialist economies, except China's industrial sector which completely dropped the bonus as a revisionist deviation. There are two basic problems involved: one is the bonus which induces a greater effort than the normal exertion, and the other is the tautness (or slackness) of the plan that discourages (or encourages) the effort. Gindin noted the effort-inducing effect of the bonus and the fear of a potentially higher new plan target when the current plan is fulfilled or overfulfilled. His model explains the managers' and planners' conflicting interest, which is inherent in a planned economy.' Leeman discussed some bonus formulae in a Soviet-type economy. He noted that if the reward were given only to the fulfillment of physical output targets, managers would tend to ignore the volume, and if the reward were based on the volume, then managers would be indifferent to plans. However, he also noted that the bonus for overfulfillment induces the managers to understate their capacities. There is a conflict in the output-plan and profit-related bonus.2 Ellman (1973) further analyzed the bonus based on the profit which reduces managers' incentive to understate the capacity. Ellman (1971) also made a detailed analysis of the institutional background of the USSR economy of the late 1960's that provides invaluable understanding of the Soviet reward system. Keren's highly analytical paper emphasizes the tautness of plans and the effortinducing bonus. Basically Keren tried to show that there exists, given a bonus, the highest permissible target, and also to show that there exists an "optimum size of bonus" which elicits the maximum exertion (effort) given the planned target.3 Mirrlees, in a recent paper, demonstrated that when the uncertainty about agents' characteristics is ignored, a nearly optimal incentive system is ". . . to threaten dire punishment of the unlucky (or lazy) and give everyone else the same payment, the payment being just high enough to make sure that people are willing to offer themselves as agents despite the threatened penalties" (p. 5). In this note, a bonus scheme which possesses some desirable characteristics is presented. It will be shown that managers operating under this reward system will have no incentive to understate or overstate their production capacity and they will strive to attain their target profits set by the planning authority. 4 * Professor of economics, Colorado State University. This work was supported by a National Science Foundation grant to the University of Minnesota. I wish to thank Leonid Hurwicz for support and encouragement. I am also grateful to an anonymous referee who provided comments for the revision of this paper but I retain sole responsibility for its content. Gindin's utility function, pp. 147-48, is