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Performance related pay

Performance related pay. 1. Background 2. Effects 3. Empirical evidence 4. Problems with PRP. 1. Background. Recall Output depends on worker effort Workers have free will effort & specific skills effort is a ‘bad’, higher wages are a ‘good’ Firms wish to maximise effort / skill use

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Performance related pay

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  1. Performance related pay • 1. Background • 2. Effects • 3. Empirical evidence • 4. Problems with PRP

  2. 1. Background • Recall • Output depends on worker effort • Workers have free will • effort & specific skills • effort is a ‘bad’, higher wages are a ‘good’ • Firms wish to maximise effort / skill use • Divergence of interests – principal-agent problem • Informational asymmetries

  3. 1. Background • ‘Old Pay’ versus ‘New Pay’ • ‘Old pay’ systems • job evaluated grade-wage structure • pay = f(time, seniority, job characteristics) • ‘New Pay’ systems • Pay related to firm’s strategy • Flexible & variable pay systems

  4. 1. Background • Types of PRP incentive scheme • (i) Piece rates: w = f(Q) • (ii) Commission on sales • (iii) Group-based PRP I.e. bonus systems (US = ‘gainsharing’) • (iv) Profit sharing

  5. 2. Effects of PRP • Three (expected) effects, compared to what? • (i) Effort & output will rise • (ii) Average level of earnings will rise • (iii) Variance of effort & wages across workers in a firm will rise

  6. 3. Empirical evidence • Lazear (2000) • Safelite Glass Corporation • Data • 3,707 workers, 19 months = 38,764 ‘person-months’ • Output = average no. of glass units installed per day in a month • Methods • Regression with & without fixed effects

  7. 3. Empirical evidence • Findings • Output per worker rose by 44 percent • A) average worker produces more – incentive scheme • B) hire more productive workers & reduction in quits amongst the most productive workers • Workers received a 10 percent increase in pay • Variance in output increased • Effect on profits? • Effect on quality of output? • Effects are large & in line with economic theory

  8. 3. Empirical evidence • Gregg, Jewell & Tonks (2005) • Executive pay & company performance in the puzzle • Panel data - UK • Time: 1994-2002 • Companies: 415 • Total observations 2,859 • Methods • ExecPayit=µi + αt + β1(CompPerform) + β2(Controls) + eit

  9. 3. Empirical evidence • Literature • Low pay-performance sensitivities for UK firms (elasticity= 0.15) • Total compensation matters more • Main et al (1996) – share option – elasticity • increased from 0.15 to 0.71 (total board remuneration) • Increased from 0.23 to 0.9 (highest paid director)

  10. 3. Empirical evidence • Findings • Total board pay rose by 33% over the period • Mean pay of highest paid director increased by 45% in real terms • Regression results • Firm size has the biggest effect • Total share holder return has a much smaller effect

  11. 4. Problems implementing PRP • a) Individual output – difficult to measure • b) Time & performance • c) Team production, effort & output • d) Teams & Group output • e) Multi-task workers – performance • Other pay mechanisms

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