Performance related pay

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Performance related pay

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

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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

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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

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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

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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

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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

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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
• 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

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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
• ExecPayitµi at ß1(CompPerform)
  ß2(Controls) eit

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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)

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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

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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