Cost of Effort in Benchmarking: Exploration and Applications

The literature on incentives suggests that the cost of effort is a key determinant of production, as an agent’s utility is dependent on both consumption and the cost of effort. However, the benchmarking literature has neglected to consider the cost of effort in performance improvement, as it primarily focuses on selecting best-practice benchmarks for underperforming agents. This paper aims to bridge these two literatures by examining the cost of effort in benchmarking and its applications. Our approach is a direct extension of the rational inefficiency hypothesis. We use the information of slacks regarding technology to make inference about the cost of effort in benchmarking. Importantly, we show that inference about the cost of effort gives new sights into activity planning, incentive provision, and employee layoffs. Our analysis provides a new explanation for benchmarking failure in business practices. It also contributes to the rational inefficiency hypothesis by revealing that inefficiency can be beneficial in benchmarking since it can be regarded as a form of fringe reimbursement provided to stakeholders to offset the cost of effort.