(Unavoidable) dynamics in incentive design

In this chapter we argue that portraying organizational design as a static engineering problem is misguided, and may lead firms to fall into a trap of deteriorating performance and increasing misalignment between behaviors and overall objectives. We highlight and discuss three endogenous mechanisms driving a need for a dynamic approach to incentives. First, complex complementarities among targeted behaviors and a fundamental multi-tasking problem create an unavoidable need to periodically redesign pay systems. Second, individuals learn, over time, how to optimally respond to incentives in ways that are both productive and unproductive for the organization. Finally, incentives are distributed within a social community rife with social comparisons, and any adjustment to rewards has a rippling effect on the organization whereby peers recalibrate perceptions of fairness and respond in ways that directly or indirectly shape incentives. We conclude by discussing implications for organizational architects and areas for future research.