Question

4. Testing Incentive Pay (in Theory). In January 2016 Starbucks introduced incen- tive pay into its California stores, so managers get 2% of revenue.! In Oregon and Washington, stores pay managers a fixed wage. You initially have cross-sectional data on annual revenue for 2016 for all California, Oregon and Washington stores. You observe that the mean revenue in California stores is significantly larger than Oregon and Washington stores. (a) Can we conclude that incentive pay raises revenue? Explain how location can cause omitted variable bias. If you know the location of every store, what analysis can you do to reduce this bias? Explain why this analysis may work, and why is may not. (b) What other store characteristics may interfere with the comparison. What data would you like to help you to make this conclusion? Suppose we have concluded that incentive pay raises revenue (as best as we can) (c) Can we conclude that Starbucks should role out the scheme across the US? data would you need to test this? What analysis would you perform? (d) Can we conclude that incentive pay makes managers work harder? What extra

Answer 1

(a) It is given that after the incentive pay, managers will get 2% of the revenues. This will motivate the managers to work a little harder and increase their revenues. The greater the revenues, the more will be the incentives.Thus we can conclude that incentive pay raises revenue.

Omitted variable bias occurs when we do not include all the factors affecting the decision or when one of the factors is left out. If we consider the revenues of all the stores without considering their location, we will get different and biased revenues because incentive pays are allowed to the California stores only.Thus Location of the stores can cause omitted variable bias. If we know the location of every store ,we would be able to get the revenues accordingly. This will help in getting the real outcome and information.

(b) When we are comparing the revenues of all the stores, we must take into account all the factors affecting the revenues.Some of them are;the location of the store,Varieties of products offered by the store, Number of workers in the store, Quality of services offered to the stores, Salaries given to the workers, Incentive pays,etc. These all factors will help in concluding the comparison.

(c) As we concluded in part (a), incentive pays increase revenues of the stores. This would also work if Starbucks role out the scheme across the US. Managers will get the motivation to work harder that will increase their revenues and hence their income.

(d) Incentive pay pushes the managers to work harder. Working hard will increase their revenues. As it is given that they will get 2% of the revenues , Thus the greater the revenues the more will be their income. Therefore, it can be concluded that incentive pay makes managers work harder. To test this, we can record the daily earning of the store after the incentive pay decision and can compare it with the earlier records.Or we can compare two different stores, one with the incentivs and one without incentives.