Within-job wage inequality: the nexus between performance pay and match quality

Over recent decades, we find about $80\%$ of widening residual wage inequality to be within jobs (industry-occupation pairs). To explore the underlying drivers, we incorporate into a sorting equilibrium framework with two extensive margin channels (across-job sorting and within-job selection of a performance-pay position) and an intensive margin channel (quality of skill match), in addition to residual job productivity. We show that equilibrium sorting is positively assortative both within and across jobs. By calibrating the model to the United States in 1990 and 2000, we find the improved match quality and rising performance-pay incidence amplify each other, jointly accounting for about $90\%$ of the widening within-job wage inequality. Match quality and performance pay are particularly important in jobs with rising average wages and expansionary employment. Once performance pay and match quality channels are incorporated, job sorting becomes less important and residual job productivity becomes inconsequential throughout.