Copyright © 2009 Pearson Education, Inc Topic 6-2. (Ch. 11) Effort, Productivity, and Pay
Copyright © 2009 Pearson Education, Inc Figure 11.1: Two Alternative Divisions of the Surplus
Copyright © 2009 Pearson Education, Inc Implicit Contracts Monitoring is costly needs an implicit contracts: incentive to induce self- monitoring (cf. explicit contract) Should be self-enforcing since it cannot be enforced by legal means Should be incentive compatible: the agreements where is in the best interest of each party to honor the agreement
Copyright © 2009 Pearson Education, Inc Piece Rate Pay Piece rate: according to output Hourly wage: time rate regardless of output Salary / flat rate Piece rate is common where the pace of work is under the control and where it is easy to measure the output If cooperation is important, group incentive is more important. Piece rates are less common in large companies
Copyright © 2009 Pearson Education, Inc Evidences of piece rate Piece rate workers receive higher wage > time rate. Maybe because more able workers chooses job offer that offer piece-rate Wage dispersion: Commissions > time-rate pay Group piece rate < individual piece rate Often regulated by quota by union
Copyright © 2009 Pearson Education, Inc Difficulties of piece rate It is hard to monitor the quality of output in a piece rate plan If employees can determine their own production process, it has perverse incentive (Czech republic doctors case: increased the number of procedures performed)
Copyright © 2009 Pearson Education, Inc Salary Employees maintains a good deal of control over the pace of work Output is difficult to measure The time it will take to complete task is uncertain Incentive for investment in human capital (participate in employer sponsored training program)
Copyright © 2009 Pearson Education, Inc Bonuses, profit sharing, and effort Bonus: extra payments to workers based on assessments of their output (larger portion of payment for some jobs: real estate agencies) Group profit sharing: bonus based on performance of their division or department. Could be seen in more profitable firms.
Copyright © 2009 Pearson Education, Inc Efficiency wages Paying high wages cause workers to provide greater effort (prohibit “shirking”) Absolute wage: nutrition based Relative wage: better paid can get better applicants and less turnover Evidence: Ford motor company $5 pay a day in Absenteeism 10% 0.5% Shock theory: reduce inefficiency in management
Copyright © 2009 Pearson Education, Inc Job Hierarchies in Pay Job ladders: Port of entry & internal labor market create long term attachment to single employer. Employers need a pay structure 1)Motivate workers to be more productive 2)Encourage workers to leave the firm when their productivity falls short of their wage 3)Provide a way to determine who should move up to the ladder
Copyright © 2009 Pearson Education, Inc Why wages rise by tenure 1)Skill 2)Good match 3)Incentive: delayed payments (ex: pension). Workers receive all benefit by extra effort Evidence: if monitoring is easy less likely to have delayed payments Incentive to cheat for firm? reputation game. Mandatory retirement is an issue
Copyright © 2009 Pearson Education, Inc Figure 11.2: A Compensation Sequencing Scheme to Increase Worker Motivation
Copyright © 2009 Pearson Education, Inc Figure 11.3: Alternative Explanations for the Effect of Job Tenure on Wages
Copyright © 2009 Pearson Education, Inc Tournament and executive pay Winner takes all: only relative output matters. Uncertainty makes the system better. Payoff must be larger if 1) The more competitors 2) Competitors are homogenous 3) Horizon becomes shorter Sabotage: only relative performance matters Evidence: 1)Larger prize better performance 2)The more competitors, the more homogenous workers, the shorter horizons least to better compensation
Copyright © 2009 Pearson Education, Inc Up or out contract Professors or lawyers promotion Firm pay wage regardless effort for given period of time workers do not have any incentive to misrepresent of the productivity given period of time
Copyright © 2009 Pearson Education, Inc Shirking and unemployment How much will employers have to pay so that workers do not shirk? Cost of shirking is losing their job. NSC’ NSC
Copyright © 2009 Pearson Education, Inc More on shirking condition If unemployment insurance goes up, the N (No shirking condition) moves to the left since employers should pay higher wages to induce them not to shirk Evidences -W-W(local average) higher fewer workers are dismissed -Strong negative relationship between local unemployment rate and current wages controlling for other factors
Copyright © 2009 Pearson Education, Inc Efficiency wages and industry wage differentials Earnings differential across industry exist In part because of different skill required or compensating wage differential or existence of unions Controlling for all these the wage differential still exist. Why? Maybe monitoring problems (size differentials)
Copyright © 2009 Pearson Education, Inc Firm size wage differentials Hard to monitor workers in large firms 1)Efficiency wage is smaller for workers with less capital equipment (capital is expensive) 2)Smaller in unionized plants: union rules render monitoring systems 3)Bigger if workers control their own working hours (flexibility)
Copyright © 2009 Pearson Education, Inc Self Employment US: 8%, Greece and Italy:25% Reasons: hard to find regular jobs (rise with recession). Employee-protection regulation. Self monitoring. Sometimes tax evasion.
Copyright © 2009 Pearson Education, Inc Self Employment (cont’d)