Dynamic Incentives in Sales Force Compensation

To inform the design of sales force compensation plans when carryover effects exist, we propose a dynamic model where these effects, together with present selling efforts, drive sales. Our results show that a salesperson with low risk aversion exerts effort to decrease attrition from existing business, whereas a salesperson with high risk aversion does not. Why? Because carryover increases not only expected sales but also sales uncertainty. Consequently, the manager should incentivize the high risk-aversion salesperson with a concave compensation plan to counterbalance suboptimal customer attrition, and the low risk-aversion salesperson with a convex compensation plan that limits coasting on past efforts. We generalize our results to when the firm employs multiple salespeople, and when advertising and personal selling are budgeted together.