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

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Presentation on theme: "Performance related pay 1. Background 1. Background 2. Effects 2. Effects 3. Empirical evidence 3. Empirical evidence 4. Problems with PRP 4. Problems."— Presentation transcript:

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

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

3 1. Background Old Pay versus New Pay Old Pay versus New Pay –Old pay systems job evaluated grade-wage structure job evaluated grade-wage structure pay = f(time, seniority, job characteristics) pay = f(time, seniority, job characteristics) –New Pay systems Pay related to firms strategy Pay related to firms strategy Flexible & variable pay systems Flexible & variable pay systems

4 1. Background Types of PRP incentive scheme 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

5 2. Effects of PRP Three (expected) effects, compared to what? 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

6 3. Empirical evidence Lazear (2000) Lazear (2000) –Safelite Glass Corporation –Data 3,707 workers, 19 months = 38,764 person- months 3,707 workers, 19 months = 38,764 person- months Output = average no. of glass units installed per day in a month Output = average no. of glass units installed per day in a month –Methods Regression with & without fixed effects Regression with & without fixed effects

7 3. Empirical evidence Findings Findings –Output per worker rose by 44 percent A) average worker produces more – incentive scheme A) average worker produces more – incentive scheme B) hire more productive workers & reduction in quits amongst the most productive workers B) hire more productive workers & reduction in quits amongst the most productive workers –Workers received a 10 percent increase in pay –Variance in output increased –Effect on profits? –Effect on quality of output? Effects are large & in line with economic theory Effects are large & in line with economic theory

8 3. Empirical evidence Gregg, Jewell & Tonks (2005) Gregg, Jewell & Tonks (2005) –Executive pay & company performance in the puzzle –Panel data - UK Time: Time: Companies: 415 Companies: 415 Total observations 2,859 Total observations 2,859 –Methods ExecPay it =µ i + α t + β 1 (CompPerform) + β 2 (Controls) + e it ExecPay it =µ i + α t + β 1 (CompPerform) + β 2 (Controls) + e it

9 3. Empirical evidence Literature Literature –Low pay-performance sensitivities for UK firms (elasticity= 0.15) –Total compensation matters more Main et al (1996) – share option – elasticity 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)

10 3. Empirical evidence Findings 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 Firm size has the biggest effect Total share holder return has a much smaller effect Total share holder return has a much smaller effect

11 4. Problems implementing PRP a) Individual output – difficult to measure a) Individual output – difficult to measure b) Time & performance b) Time & performance c) Team production, effort & output c) Team production, effort & output d) Teams & Group output d) Teams & Group output e) Multi-task workers – performance e) Multi-task workers – performance Other pay mechanisms Other pay mechanisms


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