Performance and the Design of Economic Incentives in New Product Development

By Antonio Davila
2000| Working Paper No. 1647

This study investigates the use of variable compensation to motivate product development managers and its impact upon the performance of product development projects. Grounded on measurement theory, the paper presents a model to explore the question of how to combine subjective and objective measures of performance contingent upon the uncertainty of the project. Next, the model is used to guide the analysis of data from 56 product development projects and understand how technology-intensive firms use variable compensation. Using a hierarchical modeling approach, I find that higher uncertainty is associated with lower variable compensation. Moreover, organizational structure, through its effect upon the allocation of uncertainty among organizational participants, also affects the level of variable compensation. I also explore whether the level of variable compensation is related to better or, alternatively, worse project performance. While extrinsic rewards may motivate a manager to exert more effort, they can also reduce intrinsic motivation or focus the manager’s attention away from relevant project dimensions. I find a positive relationship between economic incentives and Project performance; however, the slope of this relationship is not linear decreases as the percentage of variable compensation increases. Finally, the paper uncovers that European companies are more likely to give a flat salary than their U.S. counterparts.