Discussion Papers 745
1 Introduction
The mere mention of teams and team compensation can make a human resources
manager quiver with emotion. (Lazear 1996, p. 47)
1 Introduction
The study of the performance of incentive schemes is crucial for the understanding how or-
ganizations form and function (Holmstrom 1982). To foster team effort, many firms use team
incentive schemes that account for a small portion of employee income (Milgrom and Roberts
1992). Following Lazear (1996), there are good reasons to suppose that team incentive sche-
mes are more effective than individual incentive schemes in inducing high employee effort, in
particular when the measurement of individual contributions is impossible or very costly. On
the other hand, team incentive schemes are likely to induce free-riding behavior (e.g., Alchian
and Demsetz 1972, Holmstrom 1982).
Team incentive schemes are typically based on profit sharing: employees are paid annual
bonuses that vary with profitability defined at the overall corporate level or at the level of an
individual division. Several empirical studies find evidence that profit sharing is associated
with higher productivity (for an overview see OECD 1995) and better financial performance
of firms (e.g., Mitchell, Lewin and Lawler 1990 for the US, Zhuang and Xu 1996 for China,
Bhargava 1994 for the UK, and Kraft and Ugarkovic 2006 for Germany.)
An extreme form of profit sharing is when employees own all of the company as, for exam-
ple, in partnerships that are typical in law, medicine, management consulting or architecture,
or in production cooperatives. There is a huge body of literature on worker-owned firms, both
theoretical and empirical. The latter suggests that producer cooperatives tend to enjoy higher
levels of productivity than conventional firms (e.g., Bonin, Jones and Putterman 1993.)
Putterman and Skillman (1992) present a theoretical model of effort choice in a cooperative
firm in which they examine the role of exit costs in order to reconcile the seemingly contra-
dictory lines of reasoning by MacLeod (1988) and Lin (1990). MacLeod argues that repetition
of the production relationship in a cooperative allows for the use of trigger strategies to pun-
ish deviations from efficient output. He points out that worker mobility might hamper threats
of future punishment and thus calls for exit costs as an important criterion for a successful
cooperative. Lin, on the other hand, suggests that effective cooperation depends on the free-
dom to exit. She argues “that high-effort outcomes were achieved in Chinese farm coopera-
tives prior to 1958 because members enjoyed the right to return to private farming at will, and