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Performance Pay and Enterprise Productivity: The Details Matter

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  • Kato, Takao
  • Kauhanen, Antti

Abstract

Much of the empirical literature on PRP (Performance Related Pay) focuses on a question of whether the firm can increase firm performance in general and enterprise productivity in particular by introducing PRP and if so, how much. However, not all PRP programs are created equal and PRP programs vary significantly in a variety of attributes. This paper provides novel and rigorous evidence on the productivity effect of varying attributes of PRP and shows that the details of PRP indeed matter. In so doing we exploit the panel nature of our Finnish Linked Employer-Employee Data on the details of PRP. We first establish that the omitted variable bias is serious, makes the cross-sectional estimates on the productivity effect of the details of PRP biased upward substantially. Relying on the fixed effect estimates that account for such bias, we find: (i) group incentive PRP is more potent in boosting enterprise productivity than individual incentive PRP; (ii) group incentive PRP with profitability as a performance measure is especially powerful in raising firm productivity; (iii) when a narrow measure (such as cost reduction) is already used, adding another narrow measure (such as quality improvement) yields no additional productivity gain; and (iv) PRP with greater Power of Incentive (the share of PRP in total compensation) results in greater productivity gains yet returns to Power of Incentive diminishes very slowly.

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Bibliographic Info

Paper provided by The Research Institute of the Finnish Economy in its series ETLA Working Papers with number 21.

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Length: 22 pages
Date of creation: 26 Sep 2013
Date of revision:
Handle: RePEc:rif:wpaper:21

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  1. Dohmen, Thomas & Falk, Armin, 2006. "Performance Pay and Multi-dimensional Sorting: Productivity, Preferences and Gender," IZA Discussion Papers 2001, Institute for the Study of Labor (IZA).
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  3. Gielen, A. C. & Kerkhofs, M.J.M. & Ours, J.C. van, 2010. "How performance related pay affects productivity and employment," Open Access publications from Tilburg University urn:nbn:nl:ui:12-3583553, Tilburg University.
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  6. Alex Bryson & Richard Freeman, 2008. "How Does Shared Capitalism Affect Economic Performance in the UK?," CEP Discussion Papers dp0885, Centre for Economic Performance, LSE.
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  8. Martin Conyon & Richard B. Freeman, 2004. "Shared Modes of Compensation and Firm Performance U.K. Evidence," NBER Chapters, in: Seeking a Premier Economy: The Economic Effects of British Economic Reforms, 1980-2000, pages 109-146 National Bureau of Economic Research, Inc.
  9. Derek C. Jones & Takao Kato, 2011. "The The Impact of Teams on Output, Quality and Downtime: An Empirical Analysis Using Individual Panel Data," Industrial and Labor Relations Review, ILR Review, Cornell University, ILR School, vol. 64(2), pages 215-240, January.
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  15. Canice Prendergast, 1999. "The Provision of Incentives in Firms," Journal of Economic Literature, American Economic Association, vol. 37(1), pages 7-63, March.
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  17. James Levinsohn & Amil Petrin, 2003. "Estimating Production Functions Using Inputs to Control for Unobservables," Review of Economic Studies, Wiley Blackwell, vol. 70(2), pages 317-341, 04.
  18. Wooldridge, Jeffrey M., 2009. "On estimating firm-level production functions using proxy variables to control for unobservables," Economics Letters, Elsevier, vol. 104(3), pages 112-114, September.
  19. Douglas L. Kruse, 1993. "Profit Sharing: Does It Make a Difference?," Books from Upjohn Press, W.E. Upjohn Institute for Employment Research, number ps.
  20. Joseph Blasi & Michael Conte & Douglas Kruse, 1996. "Employee stock ownership and corporate performance among public companies," Industrial and Labor Relations Review, ILR Review, Cornell University, ILR School, vol. 50(1), pages 60-79, October.
  21. Kauhanen, Antti & Napari, Sami, 2011. "Career and Wage Dynamics: Evidence from Linked Employer-Employee Data," Discussion Papers 1244, The Research Institute of the Finnish Economy.
  22. Chris Doucouliagos, 1995. "Worker participation and productivity in labor-managed and participatory capitalist firms: A meta-analysis," Industrial and Labor Relations Review, ILR Review, Cornell University, ILR School, vol. 49(1), pages 58-77, October.
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