Luck in a Flat Hierarchy: Wages, Bonuses and Noise

Abstract

We study bonuses in a flat hierarchy and find effort optimality to be violated within a two worker-type model with noisy performance indicators. Dedicated workers extract informational rents from firms whilst slack worker effort is inefficiently low. Whilst increases in measurement noise reduce the supply-side effort effects of bonuses, they also induce demand-side responses from firms seeking to counteract falling worker exertion by increasing bonuses. Our model helps to explain empirical observations that bonuses are more prevalent and larger in jobs with noisy environments, such as within the financial sector.