The Effect of Performance-Based Incentive Contracts on System 1 and System 2 Processing in Affective Decision Contexts: fMRI and Behavioural Evidence

Managers’ affective reactions to decision contexts can lead to economically-undesirable choices for firm owners, but prior research uses settings in which pay is based on fixed wage contracts. Using theories of dual cognitive processing and knowledge accessibility, we predict that in affective contexts, performance-based contracts lead managers to make more economically-desirable choices, but for reasons beyond only goal alignment. Specifically, while a performance-based contract is unlikely to eliminate managers’ affective (“System 1”) reactions, the combination of an affective decision context and a performance-based contract induces more analytical (“System 2”) processing compared to decisions that are relatively affect-neutral. We use a functional magnetic resonance imaging (fMRI) experiment to assess brain activity and choice in the presence and absence of affective reactions under fixed wage and performance-based contracts, and supplement results with a lab experiment. Results show that brain regions associated with System 1 processing are more active in affective thannon-affective contexts under both contracts. Performance-based contracts, however, induce System 2 activation in affective contexts above and beyond that observed absent affect, and increase the proportion of economically-desirable choices inaffective contexts relative tothe proportion observed under a fixed wage contract.

This seminar is organised by the Erasmus Accounting Research Group.