Technology Choice, Relative Performance Pay, and Worker Heterogeneity

We identify a new problem that may arise when heterogeneous workers are motivated by relative performance pay: If workers' abilities and the production technology are complements, the firm may prefer not to adopt a more advanced technology even though this technology would costlessly increase each worker.s productivity. Due to the complementarity between ability and technology, under technology adoption the productivity of a more able worker increases more strongly than the productivity of a less able colleague. As a consequence, both workers' motivation to exert effort is reduced. We show that this adverse incentive effect is dominant and, consequently, keeps the firm from introducing a better production technology if talent uncertainty is sufficiently high and/or monitoring of workers is sufficiently precise.