Indranil Goswami and I have a new working paper up.  We were interested in the consequences of misestimating time, and looked at contract choices.  We have some participants serve as workers, doing a task, like solving jigsaw puzzles.  The workers are either paid a flat fee, or are paid for the time they spend on the task. We have other participants serve as managers, making choices between hiring a worker with a fixed fee contract or a per-time contract.

We find that the “managers” generally prefer the fixed fee contracts, even though the per-time contracts are actually more profitable. Prior research has also found a ” flat-rate bias” in contexts such as gym memberships and service contracts. Years ago, before I knew about any of the research, I also stumbled across it in the results of a conjoint marketing research study I worked on for a telecommunications company. This puzzled all of us at the marketing research firm, accustomed to thinking of consumers as simply hunting for the best deal.

One explanation is that flat rate deals provide a kind of insurance — even if they are more expensive on average, they eliminate a costly worst-case scenario. A more recently proposed explanation is that people don’t like having to feel like each additional bit of consumption is costing them. When you’re texting your friends, you want to just enjoy texting your friends, not do a cost-benefit analysis of whether each text is actually worth the cost.

In our context, the culprit turns out to be different — misestimation of how long the workers will take. We find that the managers choose the flat-fee mainly when their own time estimates suggest that the flat-fee would be a better deal. It doesn’t seem to be about insuring against the worst-case scenario of an expensive, slow worker, because they are much less interested in the certain option, when given a choice between a certain amount and a gamble, constructed to be equivalent to their contract choice.

The best evidence that it’s about misestimating workers’ time comes from time limits.  We give the workers either a short time-limit or a long time-limit to complete the task. The contracts are set up such a way that the per-time contract is a better deal than the flat fee in both cases, but the advantage of the per-time contract is even stronger when the time limit is longer.

So, based on just the incentives, our “managers” should be less likely to choose the flat fee contract under the long time-limit. But instead, more of our managers choose the flat fee contract under the long time-limit. Why? Because under the long-time limit they also over-estimate how long the workers will take to a greater degree than under the short time-limit.  This turns out to be a very robust finding, observed with different kinds of tasks and among participants with management experience.

I think this may hint at something broader about the eternal battle between “carrot” and “stick” philosophies. Managers often have strong views about whether they should be creating a hospitable environment in which workers can unleash their creativity and productivity, or creating a tightly controlled environment to prevent overspending and inefficiency, recognizing that the two are at least somewhat incompatible.  Those views may often be based a lot more on personal philosophies than on being well-calibrated to the optimal strategy in a given setting.