performance pay work under two conditions: First, employees need to believe that increased effort leads to increased performance, second increased performance leads to desired outcomes and is recognized by management. If the two conditions are met, employees form a behaviorally salient expectation about a future reward and adjust their work effort upwardly. Reinforcement theory stresses the effect of cultivating a behavioral norm of high work effort through reinforcing behavior with positive rewards. Apart from the direct link between performance and individual rewards, advocates in the field of public administration highlight secondary effects associated with performance pay: it helps to recruit and retain highly-skilled and/or motivated staff who presumably would do better under such an arrangement; increases the awareness for organizational goals by defining explicit performance standards; weakens the power of public sector unions; makes managers more responsible; signals core organizational goals to outside actors; increases the link between individual and organizational job goals; reduces the overall wage bill by moving away from automatic pay increases; and leads to an increase in overall job satisfaction through the individual recognition of employee efforts (Marsden 2004; OECD 2005b; Marsden 2009).

Critics of performance pay point out that the two conditions of expectancy theory are not always met and it is in principle difficult to design performance pay schemes that work as intended. Furthermore, critics argue humans do not always approach work effort and the assessment of salary in an entirely rational way and thus invalidate simple theoretical models based on rational-actor assumptions. In addition, measuring performance in the public sector is often fraught with difficulty. Many core public servants perform services on a daily basis that are hard to measure or are non-measurable, or produce outputs that are not market-priced. For example, early critics of test score based school and teacher evaluations argued that teacher performance cannot be neatly summarized by mechanic student test scores and such practice usually invites behavior that contradicts the overall goals of the teaching profession (Murnane and Cohen 1986). Interestingly, these criticisms were already leveled against early forms of test-based performance pay in British schools in the 19th century (Gratz 2009). Using explicit and objective performance measures can induce tunnel vision, myopia and measure fixation (Propper and Wilson 2003). Additionally, there is a lack of clarity about who determines and evaluates performance, and civil servants often work in large teams under the supervision of multiple managers, complicating the attribution of performance and responsibility of evaluation. Some authors see as a necessary condition the presence of high levels of trust and transparency between employees and management, to avoid arbitrary implementation and worker dissatisfaction (Kellough and Lu 1993).

An influential article (Kerr 1975) identified scenarios in which well-intended incentive schemes ended up favoring behavioral responses by employees that fulfill performance criteria, but taken to the extreme contradict overall organizational goals and standards. A different strand of criticism focuses on other motivations underlying public servants' effort. Apart from pure monetary rewards as expressed in salary, civil servants, it is argued, are motivated by notions of altruism, prosocial behavior and commitment to institutional goals (Perry and Hondeghem 2008), which are seen to compete with or even stand in conflict with explicit monetary incentives.

# **Incentive and principal-agent theory**

Several surveys have synthesized the theoretical literature on pay incentive systems for the private sector (Prendergast 1998, 1999), for the public sector (Dixit 1999; Burgess and Ratto 2003) and specialized occupations such as teaching (Neal 2011). The most basic argument for incentive pay is founded in a simple microeconomic principal-agent model of labor relations, in which a principal (the employer) wants to induce an agent (the employee) to perform a certain task. Such principal-agent relationships are commonly affected by two problems (Dixit 1999): moral hazard and adverse selection.

5