Incentives and Gaming in a Nonlinear Compensation Scheme

Purpose - Under a discontinuous and nonlinear compensation scheme, which is prevalent among car dealerships, the amount of a salesperson's expected daily commission depends primarily on his position in the pay schedule on the day he makes a sale. Salespeople thus vary their efforts and adopt a different pricing strategy week by week, or even day by day. The purpose of this paper is to examine the incentive effect of such a nonlinear scheme and provide the evidence that salespeople's behavior is consistent with the theory. Design/methodology/approach - The authors conduct regression analyses using the transaction data provided by two North American auto dealerships. The authors construct a daily measure of varying incentive intensity and evaluate its impact on the distribution of individual daily sales and the dealership's gross profit rate. Findings - The authors find that the daily measure of varying incentive intensity has a positive effect on the distribution of individual daily sales and a negative impact on the dealership's gross profit rate. The results suggest that: salespeople adjust their effort levels in response to the intensity of incentives; and they game the system by lowering the prices when the marginal return to doing so is high. Research limitations/implications - The study shows that there is a high cost associated with the discontinuous nonlinear pay scheme, raising the question of why many auto dealerships use it. Originality/value - This paper sheds light on the undesirable aspects of discontinuous and nonlinear incentive schemes, varied performance and gaming, by quantifying the effects of the worker's behavior.