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Performance Pay and Earnings: Evidence from Personnel Records

  • Pekkarinen, Tuomas

    ()

    (Government Institute for Economic Research, Helsinki)

  • Riddell, Chris

    ()

    (Cornell University)

This paper examines the effects of performance pay on earnings using linked employee-employer panel data from Finland. These payroll data contain information on the exact share of earnings obtained and hours worked on a performance pay contract. Using these data, we estimate the effects of performance pay in the presence of both individual and firm-specific unobserved heterogeneity. Furthermore, we are able to estimate the effects of performance pay contracts in tasks of different complexity and for the subsample of workers who change jobs following an establishment closure. Unobservable firm characteristics explain 30-50% of the variance in performance pay. After controlling for unobservable individual and firm characteristics, performance pay workers earn substantially more than fixed rate workers. The effects persist when only workers who changed firms, and contracts, due to an establishment closure are used for identification. There is also a strong, negative relationship between job complexity and the incentive effects of performance pay. Finally, we exploit several ‘natural experiments’ where there was a compensation regime change in one plant of a given firm, but not in other plants. The plants are highly similar pre-regime change, and had a common trend in earnings pre-regime change. These experiments also yield substantial earnings premiums.

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Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 2253.

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Length: 43 pages
Date of creation: Aug 2006
Date of revision:
Publication status: published in: Industrial and Labor Relations Review, 2008, 61 (3), 287 - 319
Handle: RePEc:iza:izadps:dp2253
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  1. Edward P. Lazear, 1996. "Performance Pay and Productivity," NBER Working Papers 5672, National Bureau of Economic Research, Inc.
  2. Charles Brown, 1992. "Wage Levels and Method of Pay," RAND Journal of Economics, The RAND Corporation, vol. 23(3), pages 366-375, Autumn.
  3. Booth, Alison L & Frank, Jeff, 1999. "Earnings, Productivity, and Performance-Related Pay," Journal of Labor Economics, University of Chicago Press, vol. 17(3), pages 447-63, July.
  4. Daniel Parent, 1999. "Methods of pay and earnings: A longitudinal analysis," Industrial and Labor Relations Review, ILR Review, Cornell University, ILR School, vol. 53(1), pages 71-86, October.
  5. Lazear, Edward P, 1986. "Salaries and Piece Rates," The Journal of Business, University of Chicago Press, vol. 59(3), pages 405-31, July.
  6. Charles Brown, 1990. "Firms' Choice of Method of Pay," NBER Working Papers 3065, National Bureau of Economic Research, Inc.
  7. Gibbons, Robert & Waldman, Michael, 1999. "Careers in organizations: Theory and evidence," Handbook of Labor Economics, in: O. Ashenfelter & D. Card (ed.), Handbook of Labor Economics, edition 1, volume 3, chapter 36, pages 2373-2437 Elsevier.
  8. Groshen, Erica L, 1991. "Sources of Intra-industry Wage Dispersion: How Much Do Employers Matter?," The Quarterly Journal of Economics, MIT Press, vol. 106(3), pages 869-84, August.
  9. Daniel Parent, 2001. "The Effect of Pay-for-Performance Contracts on Wages," CIRANO Working Papers 2001s-05, CIRANO.
  10. Canice Prendergast, 1999. "The Provision of Incentives in Firms," Journal of Economic Literature, American Economic Association, vol. 37(1), pages 7-63, March.
  11. John M. Abowd & Robert H. Creecy & Francis Kramarz, 2002. "Computing Person and Firm Effects Using Linked Longitudinal Employer-Employee Data," Longitudinal Employer-Household Dynamics Technical Papers 2002-06, Center for Economic Studies, U.S. Census Bureau.
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