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The effect of pay-for-performance contracts on wages

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  • Daniel Parent

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Abstract

In this paper, I investigate the role played by learning and self-selection according to comparative advantage in the often reported result that piece rate workers (including commissions) earn more on average compared to other workers. With comparative advantage, the returns to skills are different according to whether one works under a piece rate contract or not. If that is the case, as Lazear (1986)'s model suggests, then using standard fixed effects methods will not provide consistent estimates of the true causal (or incentive) effect of explicit contracts. Using non-linear instrumental variable techniques with data from the National Longitudinal Survey of Youth and the Panel Study of Income Dynamics, I find that comparative advantage along with learning about worker skills seem to play a significant role for workers who are either at an early stage in their career or who are observed for the first time in a given job-match, when the learning process matters. In other words, for those younger/early tenure workers, the return to skills is lower in non-incentive jobs. For older workers, the return to skills is basically the same across pay methods, which is consistent with the notion that workers are eventually paid according to their fully revealed skill level, irrespective of how they are paid. Finally, by exploiting the within-job variation in pay methods, I am able to identify an incentive effect of about 11%. Cet article cherche à évaluer le rôle joué par les avantages comparés eu égard au résultat fréquemment rencontré qui veut que les travailleurs payés à la pièce ou par commission soient mieux rémunérés que les travailleurs salariés (incluant ceux qui sont payés à l'heure). Selon le modèle de Lazear (1986), la sensibilité de la rémunération à la pièce par rapport à la productivité est plus grande que dans les boulots salariés. Les avantages comparés impliquent donc que les travailleurs intrinsèquement plus productifs choisiront

(This abstract was borrowed from another version of this item.)

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Bibliographic Info

Article provided by Springer in its journal Empirical Economics.

Volume (Year): 36 (2009)
Issue (Month): 2 (May)
Pages: 269-295

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Handle: RePEc:spr:empeco:v:36:y:2009:i:2:p:269-295

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Related research

Keywords: Incentives; Returns to skills; Comparative advantage;

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References

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  1. Robert Gibbons & Lawrence F. Katz & Thomas Lemieux & Daniel Parent, 2005. "Comparative Advantage, Learning, and Sectoral Wage Determination," Journal of Labor Economics, University of Chicago Press, vol. 23(4), pages 681-724, October.
  2. Murphy, K.J. & Gibbons, R., 1990. "Optimal Incentive Contracts in the Presence of Career Concerns : Theory and Evidence," Papers 90-09, Rochester, Business - Managerial Economics Research Center.
  3. Richard B. Freeman, 1983. "Longitudinal Analyses of the Effects of Trade Unions," NBER Working Papers 1207, National Bureau of Economic Research, Inc.
  4. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-54, July.
  5. Henry S. Farber & Robert Gibbons, 1994. "Learning and Wage Dynamics," Working Papers 707, Princeton University, Department of Economics, Industrial Relations Section..
  6. Lazear, Edward P, 1986. "Salaries and Piece Rates," The Journal of Business, University of Chicago Press, vol. 59(3), pages 405-31, July.
  7. Ewing, Bradley T., 1996. "Wages and performance-based pay: Evidence from the NLSY," Economics Letters, Elsevier, vol. 51(2), pages 241-246, May.
  8. W. Bentley MacLeod & Daniel Parent, 1998. "Job Characteristics and the Form of Compensation," CIRANO Working Papers 98s-08, CIRANO.
  9. Rajesh K. Aggarwal & Andrew A. Samwick, 1999. "The Other Side of the Trade-off: The Impact of Risk on Executive Compensation," Journal of Political Economy, University of Chicago Press, vol. 107(1), pages 65-105, February.
  10. Lemieux, Thomas, 1998. "Estimating the Effects of Unions on Wage Inequality in a Panel Data Model with Comparative Advantage and Nonrandom Selection," Journal of Labor Economics, University of Chicago Press, vol. 16(2), pages 261-91, April.
  11. Robert Gibbons & Michael Waldman, 1998. "A Theory of Wage and Promotion Dynamics in Internal Labor Markets," NBER Working Papers 6454, National Bureau of Economic Research, Inc.
  12. Edward P. Lazear, 1996. "Performance Pay and Productivity," NBER Working Papers 5672, National Bureau of Economic Research, Inc.
  13. Garen, John E, 1994. "Executive Compensation and Principal-Agent Theory," Journal of Political Economy, University of Chicago Press, vol. 102(6), pages 1175-99, December.
  14. Frazis, Harley & Loewenstein, Mark A., 2003. "Estimating linear regressions with mismeasured, possibly endogenous, binary explanatory variables," Journal of Econometrics, Elsevier, vol. 117(1), pages 151-178, November.
  15. Card, David, 1996. "The Effect of Unions on the Structure of Wages: A Longitudinal Analysis," Econometrica, Econometric Society, vol. 64(4), pages 957-79, July.
  16. repec:eme:rlepps:v:18:y:1999:i:1999:p:177-242 is not listed on IDEAS
  17. Bentley MacLeod & James M. Malcomson, 1985. "Reputation and Hierarchy in Dynamic Models of Employment," Working Papers 628, Queen's University, Department of Economics.
  18. Charles Brown, 1992. "Wage Levels and Method of Pay," RAND Journal of Economics, The RAND Corporation, vol. 23(3), pages 366-375, Autumn.
  19. Daniel Parent, 1997. "Methods of Pay and Earnings: A Longitudinal Analysis," CIRANO Working Papers 97s-14, CIRANO.
  20. Jovanovic, Boyan, 1979. "Job Matching and the Theory of Turnover," Journal of Political Economy, University of Chicago Press, vol. 87(5), pages 972-90, October.
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Citations

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Cited by:
  1. Pekkarinen, Tuomas & Riddell, Chris, 2006. "Performance Pay and Earnings: Evidence from Personnel Records," IZA Discussion Papers 2253, Institute for the Study of Labor (IZA).
  2. Felipe Balmaceda, 2004. "Uncertainty, Pay for Performance and Adverse Selection in a Competitive Labor Market," Documentos de Trabajo 196, Centro de Economía Aplicada, Universidad de Chile.
  3. Sabrina Teyssier, 2008. "Les Modes de Rémunération comme MécanismesSélectifs de la Main d'oeuvre : Fondements Théoriques et Estimations Empiriques," Post-Print halshs-00303703, HAL.
  4. Henneberger, Fred & Sousa-Poza, Alfonso & Ziegler, Alexandre, 2007. "Performance Pay, Sorting, and Outsourcing," IZA Discussion Papers 3019, Institute for the Study of Labor (IZA).

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