Designing Incentives for Unobservable Effort: A Case Study on Performance-Based Pay

Abstract

Imagine a delivery driver for a logistics company who can choose between two levels of effort: (1) go the extra mile (high effort) or (0) stick to the basics (low effort). The employer cannot directly observe the driver’s effort but can measure performance based on delivery outcomes. The outcomes are either on-time delivery or late delivery. If the driver exerts high effort, deliveries are made on time 60% of the time and late 40% of the time. If the driver exerts low effort, deliveries are always late. Table – Delivery Performance Outcomes Effort Level On-Time Delivery Late Delivery High Effort 60% 40% Low Effort 0% 100% Task: How should the logistic ensuring fairness?