Tim Harford write an excellent column for Slate.com (He also has a great book). In this column, he discusses how a person in charge of providing incentives determines what good performance is. In his example, he discusses determining his daughter’s performance in using the toilet. I find the difficulty of determining performance to be very similar to how professors deal with determining grades. Here is an excerpt:

“She has the capacity to use the potty, so all that is now required is the right incentive. Chocolate coins turn out to be the sort of currency a 2-year-old understands. Successful use of the potty earns a chocolate coin. It works, and is money well spent.

Yet two days into the contract, problems are emerging. What is “successful use of the potty”? This morning, my nose alerted me to a borderline case: an enormous turd on the sitting room floor, and a tiny rabbit-dropping in the potty. At this early stage, we chose to accentuate (and reward) the positive. In a month’s time, I will be less impressed, but can we really move the goal posts then?

Even straightforward incentives can be manipulated. The great pole-vaulter Sergei Bubka repeatedly broke the world record by a centimeter and earned a cash bonus every time. I have visions of a near future in which Miss Harford empties her bladder one drop at a time in order to scoop bagfuls of chocolate coins.

As we are discovering, apparently black-and-white matters of performance can quickly become shades of gray. It is much more tempting to resort to discretion: If we’re happy with Miss Harford’s potty performance, chocolate coins will be forthcoming.

This sounds a bit like your boss’s vague promise of a salary review sometime the year after next. Employees know that bosses are lying weasels and wisely ignore such empty gestures. Daughters know that parents are lying weasels too, and that is why we must keep our incentive payments as unambiguous as possible.

Employers want to offer incentives for good behavior, just as parents do. But how to combine the oh-so-important discretion with the credibility needed to make the promises persuasive?

One possibility is to rely on relative performance. The boss can announce that the best three performers in the office will receive a $1,000 bonus at the end of the year. There is no weaseling out of such a promise, and there is no incentive to give the bonus to bad workers instead of good ones, but the boss retains the flexibility to decide what a good performance actually means.”