Pay per hour or flat rate? Many managers make the wrong choice

Alice G. Walton | Mar 22, 2017

With both manufacturing and the service sector becoming more lean and automated, one might think that managers have become adept at structuring work and pay efficiently. Research suggests otherwise.

Many managers prefer to pay workers a flat rate for their labor, even when paying by the hour would be more profitable, according to University at Buffalo’s Indranil Goswami and Chicago Booth’s Oleg Urminsky.

The researchers conducted an experiment in which they paid people to put together a digital jigsaw puzzle, giving them either five or 15 minutes. Goswami and Urminsky wanted to measure workers’ productivity when they’re paid a flat fee or a time-based rate. Workers paid a flat fee took slightly less time to do the puzzle, yet earned more than those paid by the minute.

Hiring managers' overestimation of how long a task will take
Study participants hired people to do a puzzle-solving task, deciding in the process whether it would be more profitable to pay a flat fee or a per-minute rate. Even when paid per minute, the hirees finished sooner than the budgeted timeframe.

However, when the researchers had a different group of people act as “managers” and choose how they wanted to pay a worker to complete the puzzle, 71 percent of managers favored the flat-rate payment, which cost them profits.

Managers were poor at estimating how long the task would take their workers. This was particularly the case when workers were given more time to complete the task. Managers predicted that workers paid by the minute would take an average of four and a half minutes to complete the task with the five-minute deadline, while it actually took them just three minutes. But managers estimated it would take an average of 13 minutes to complete the puzzle with the 15-minute deadline, even though the workers completed it, on average, in only three and a half minutes.

This miscalculation took a toll on the managers’ profits, which were 25 percent less than they could have been in the shorter task, and 35 percent less than they could have been for the longer task.

The researchers saw similar patterns when they paid people to proofread, a task for which quality matters. Once again, managers favored flat-fee payments, even when paying for workers’ time would have produced more net earnings without compromising quality. People both with and without real-world managerial experience made the same mistake.