Performance related pay

1. Background 2. Effects 3. Empirical evidence 4. Problems with PRP

1. Background

Recall
Output depends on worker effort Workers have free will effort & specific skills effort is a bad, higher wages are a good Firms wish to maximise effort / skill use Divergence of interests principal-agent
problem Informational asymmetries

1. Background

Old Pay versus New Pay

Old pay systems
job evaluated grade-wage structure pay = f(time, seniority, job characteristics)

New Pay systems Pay related to firms strategy Flexible & variable pay systems

1. Background

Types of PRP incentive scheme

(i) Piece rates: w = f(Q) (ii) Commission on sales (iii) Group-based PRP I.e. bonus systems (US = gainsharing) (iv) Profit sharing

2. Effects of PRP

Three (expected) effects, compared

to what?
(i) Effort & output will rise (ii) Average level of earnings will rise (iii) Variance of effort & wages across workers in a firm will rise

3. Empirical evidence
Lazear (2000)
Safelite Glass Corporation Data 3,707 workers, 19 months = 38,764 person-

months Output = average no. of glass units installed per day in a month

Methods Regression with & without fixed effects

3. Empirical evidence
Findings
Output per worker rose by 44 percent A) average worker produces more incentive scheme B) hire more productive workers & reduction in quits
amongst the most productive workers

Effects are large & in line with economic theory

Workers received a 10 percent increase in pay Variance in output increased Effect on profits? Effect on quality of output?

3. Empirical evidence
Gregg, Jewell & Tonks (2005)
Executive pay & company performance in the puzzle Panel data - UK Time: 1994-2002 Companies: 415 Total observations 2,859 Methods ExecPayit=i + t + 1(CompPerform) +
2(Controls) + eit

3. Empirical evidence

Literature
Low pay-performance sensitivities for UK firms (elasticity= 0.15) Total compensation matters more Main et al (1996) share option elasticity
increased from 0.15 to 0.71 (total board remuneration) Increased from 0.23 to 0.9 (highest paid director)

3. Empirical evidence

Findings
Total board pay rose by 33% over the period Mean pay of highest paid director increased by 45% in real terms Regression results Firm size has the biggest effect Total share holder return has a much smaller effect

4. Problems implementing PRP

a) Individual output difficult to measure b) Time & performance c) Team production, effort & output d) Teams & Group output e) Multi-task workers performance Other pay mechanisms