Shrouded Attributes of Workplace Incentive Contracts: The Case of the Ratchet Effect

The ratchet effect is a well-known, and theoretically well understood, side effect of time-varying incentive pay: if future piece rates are set as a function of current effort, then workers should hold back effort to protect future piece rates. The ratchet effect has been cited as a fundamental challenge to making effective use of dynamic incentive pay. We study the hypothesis that firms can strategically introduce complexity into their incentive systems to “shroud” the ratchet effect. We conduct two field experiments with 3000 warehouse workers and find a strong effect of incentives on effort but only a very small ratchet effect. In lab experiments with the same workers, we find that simplifying the incentive system used in the warehouse increases the ratchet effect. Workers who exhibit a ratchet effect in the lab experiments also reduce effort on the shop floor. Additional MTurk experiments show that these findings are robust to changes in the design of the incentive system. Our results underscore the importance of bounded rationality and complexity for the effectiveness of incentive pay.