Institute for Research on Labor and Employment

In formal organizations and particularly in work teams within organizations, the following two situations often arise. In the first, one can observe or measure only the output of the work group, not the contributions of each member. In the second, the output of each member depends not only on her own effort but also on the efforts of other workers. The problem that arises in both situations is how to construct reward or incentive schemes. In the first case, one cannot tie individual rewards to individual outputs. In the second, one can do so, but the connection between individual effort and output is blurred by the interdepen- dencies between the workers. Group piece-rate schemes are suggested remedies in both situations. However, it is wellknown that group piece-rate schemes are susceptible to free-rider problems. The classic solution to the free-rider prob-lem and to the problem of team interdependencies in general is to substitute a market-type relationship, such as a group piece-rate scheme, with an authority relationship, in which a supervisor keeps free riders in line. In this paper, I discuss an alternative solution to the free-rider problem, a solution that retains the market-type character of the piece-rate scheme but in which the relationship between output and reward is highly nonlinear. I show that a so-called target-rate scheme, either individual or group based, in which pay is high if a production target is reached and low otherwise, can solve the free-rider problem. I use evidence from establishment-level data on several thousand production workers in two U.S. industries to support this claim.