The Impact of Perceived Environmental Uncertainty and Perceived Agent Effectiveness on the Composition of Compensation Contracts

Abstract

Recently, a stream of theoretical development concerning the design of optimal compensation plans has emerged in the marketing literature. Little empirical work has been done so far to validate the theoretical predictions. The findings from the few field studies are equivocal and conflicting which we ascribe to failure to account for the major assumptions underlying the theoretical predictions. We argue that, in order to enhance the rigor of 'theory testing', the field studies must be complemented by laboratory experiments where the conditions stipulated by the assumptions of the theory can be systematically imposed and/or relaxed. This should help in the reconciliation of the differences found in the field studies. The experiment reported in this paper is a first step towards filling this void in the empirical research in this area. Here, we assess the impact of perceived environmental uncertainty and perceived agent effectiveness on the magnitude (total pay) and composition (salary-incentive mix) of employment compensation. The hypotheses stem from propositions analytically derived by Basu, Lal, Srinivasan, and Staelin (1985) and Lal and Srinivasan (1988). The insurance industry middle management compensation problem served as the experimental context. The results of the experiment ratified the hypothesis that an increase in perceived agent effectiveness leads to award of compensation contracts of larger total expected value and a larger proportion of performance-contingent pay. However, the hypothesis that an increase in perceived environmental uncertainty prompts the principal to award compensation contracts of smaller total expected value and a smaller proportion of performance-contingent pay was rejected. We discuss possible alternative explanations for the conflicting results associated with the uncertainty variable and identify future research opportunities in this area.compensation plans, agency theory, management incentive contracts, salary-incentive mix

Relative explanatory power of agency theory and transaction cost analysis in German salesforces

“…Among the studies that have investigated, hypotheses derived from AT are crosssectional studies by Coughlan and Narasimhan (1992), Joseph and Kalwani (1995) and Lal et al (1994) and laboratory experiments by Gaba and Kalra (1999) and Umanath, Ray, and Campbell (1993). In these studies, many AT-based hypotheses are supported, but for some hypotheses, the results are mixed, especially with respect to environmental uncertainty.…”

Experimental Evidence for Agency Models of Salesforce Compensation

“…Recall that the contradictory findings in the extant survey work could be attributed to the difficulty of measuring uncertainty conditional on effort. While the protocols used in prior experimental work (Umanath et al, 1993(Umanath et al, , 1996 obviated the measurement problem, they never implemented explicit functions. Hence, their results were not dispositive of the effort-output uncertainty effect.…”

“…By implementing a fully specified AT model in each experimental condition, we are able to generate stronger probes of the theory. In contrast, extant experimental protocols either fail to implement an explicit AT model (e.g., Umanath et al 1993Umanath et al , 1996 or else fail to implement one or more factors of an explicitly specified AT model (e.g., Berg et al 1992).…”

The principal-agent problem with adaptive players

“…Unlike mathematical models, simulations let us specify more complex assumptions and still get some form of solution (Law and Kelton 1982). Simulations offer an interesting contrast to existing mathematical theory (reviewed in section 2) and the empirical literature (Eisenstadt 1989;Bull et al 1987;Drayo and Heywood 1989;Schotter and Weigelt 1992;Umanath et al 1993) of the principalagent problem. This will be a complementary but orthogonal study.…”