Does Size Really Matter? Empirical Evidence on Group Incentives

The paper empirically analyzes the economic theory and intuition that the "free rider" problem will overwhelm firm-wide incentives in large firms. Kandel and Lazear (1992) claim that in a simple model of an equitable partnership, Nash equilibrium effort levels fall with the number of partners - the 1/N problem. The paper shows that this result is crucially dependent on a unstated assumption on the production function. In particular, if worker effort levels are complementary, effort levels can increase with the number of partners. This difference may explain the empirical finding that the 1/N problem is substantial in medical and legal practices (where effort levels are independent), but less important in manufacturing (where effort levels are complementary). The empirical results suggest that the use of firm-wide incentives increases with firms size, at least for smaller firms. The results do not support the claim that the use of other human resource practices, like self-managed work teams, allows the firm to mitigate the 1/N problem.