1. Copyright © 2009 Pearson Education, Inc. 11- 1 Topic 6-2. (Ch. 11) Effort, Productivity, and Pay

2. Copyright © 2009 Pearson Education, Inc. 11- 2 Figure 11.1: Two Alternative Divisions of the Surplus

3. Copyright © 2009 Pearson Education, Inc. 11- 3 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

4. Copyright © 2009 Pearson Education, Inc. 11- 4 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

5. Copyright © 2009 Pearson Education, Inc. 11- 5 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

6. Copyright © 2009 Pearson Education, Inc. 11- 6 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)

7. Copyright © 2009 Pearson Education, Inc. 11- 7 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)

8. Copyright © 2009 Pearson Education, Inc. 11- 8 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.

9. Copyright © 2009 Pearson Education, Inc. 11- 9 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 1914. Absenteeism 10%  0.5%  Shock theory: reduce inefficiency in management

10. Copyright © 2009 Pearson Education, Inc. 11- 10 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

11. Copyright © 2009 Pearson Education, Inc. 11- 11 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

12. Copyright © 2009 Pearson Education, Inc. 11- 12 Figure 11.2: A Compensation Sequencing Scheme to Increase Worker Motivation

13. Copyright © 2009 Pearson Education, Inc. 11- 13 Figure 11.3: Alternative Explanations for the Effect of Job Tenure on Wages

14. Copyright © 2009 Pearson Education, Inc. 11- 14 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

15. Copyright © 2009 Pearson Education, Inc. 11- 15 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

16. Copyright © 2009 Pearson Education, Inc. 11- 16 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

17. Copyright © 2009 Pearson Education, Inc. 11- 17 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

18. Copyright © 2009 Pearson Education, Inc. 11- 18 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)

19. Copyright © 2009 Pearson Education, Inc. 11- 19 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)

20. Copyright © 2009 Pearson Education, Inc. 11- 20 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.

21. Copyright © 2009 Pearson Education, Inc. 11- 21 Self Employment (cont’d)