Pay for performance schemes and manufacturing worker productivity: Evidence from a kinked design in China

This paper examines workers’ response to a nonlinear payment system with a penalty and a reward design in a manufacturing firm in China. Using bunching methods, our estimates show that about 31% of workers make decisions with errors, and the structural elasticity of output response to the piece rate is 0.28. The focal nonlinear payment scheme generates 4% output gains compared with a linear payment scheme given the same total wage costs. Further decomposition analysis shows that the reward aspect of the nonlinear scheme mainly contributes to total output gains. Counterfactual analyses show that total output generated by the nonlinear payment system falls with the reduced worker heterogeneity. Our results illustrate the role of worker heterogeneity in designing compensation schemes and provide new insights into the increasing adoption of nonlinear payment systems in modern manufacturing production.