The empirical effects of performance
            contracts: evidence from China
Performance contracts are widely used to
            reform state-owned enterprises. By June 1994, there were 565
            such contracts in 32 developing countries, used prinicipally
            to reform large utilities and other monopolies, and roughly
            another 103,000 in China, where they are also used to reform
            state manufacturing enterprises. A performance contract is a
            written agreement between the manager of a state enterprise
            (who promises to achieve specific targets in a certain time
            frame) and government (which--usually--promises to award
            achievement with a bonus or other incentive). Performance
            contracts are a variant of the pay-for-performance or
            incentive contracts often used to motivate managers in the
            private sector. In the public sector, they are viewed as a
            device to reveal information and motivate managers to exert
            effort. The authors analyze China's experience with
            performance contracts in more than 400 state enterprises.
            China is a good place for such a study because no country
            has ever used them on such a scale or with such a variety of
            enterprises (mostly in the competitive sector). China also
            uses many different kinds of contracts, with different
            targets (more profit-, tax-, or output-oriented). The
            authors find that performance contracts: a) on average, do
            not improve productivity in China's state enterprises
            and may even reduce it; b) are ineffective in competitive
            firms as well as monopolies; c) do more harm when they
            provide only weak incentives and when they do not reduce
            information asymmetry. They find no connection between
            variables for commitment and the effects of performance
            contracts. Design matters. When performance contracts
            contain all the "good" features--profit
            orientation, higher wage elasticity, and lower markup
            ratios--the firm's productivity growth rate could
            increase as much as 10 percent. The Chinese government was
            serious about implementing performance contracts, and used
            measures considerably more radical than other countries
            used, hailing the contract system as the official national
            mode for reforming state enterprises. But most of the
            contracts have had little or no effect on growth rates and
            the observed frequency of contracts with "good"
            provisions is exceedingly low. Perhaps the political economy
            of incentive contracts in government settings merits further
            study. Political considerations may preclude the design of
            incentive contracts for government actors could produce the
            sort of productivity gains some private firms have achieved.
            One observer (Byrd 1991) points out that the central
            government gave local governments a good deal of discretion
            in implementing performance contracts and local governments
            had a tendency to adopt the lowest common denominator, a
            "bare-bones" performance contract.