What’s the big deal with pay for performance?

What’s the big deal with pay for performance?

Keith A. Bender (University of Aberdeen) and Alex Bryson (NIESR and CEP)

Economists get pretty fixated about paying workers for their performance. That’s why we are devoting November’s Special Issue of the NIESR Review to the topic. (You can get your free copies of the articles in the Special Issue using the links below).

There are good theoretical reasons why this kind of pay should increase worker effort and attract the best workers compared to paying a fixed time rate. And some of the best studies in labour economics are testimony to the power it can have to increase labour productivity – at least in particular settings.

But there’s good reason to believe it’s not quite so important as most economists make out. First, not that many workers receive it. Around 10-15% of workers in most European countries receive it, rising to 40% in some Scandinavian countries and the United States. Second, performance payments aren’t that large for the average worker. As Alex Bryson and NIESR colleagues will show in a forthcoming paper, performance pay is usually under 10% of a firm’s wage bill. So the power of performance pay to attract or incentivise is necessarily limited – unless you believe in the power of symbolic gifts. 

Still, there are four reasons not to dismiss performance pay out of hand.  First, it plays a very important role for groups of workers that happen to count quite a lot: senior executives and Finance sector workers. Here performance pay really matters because it accounts for a large proportion of total pay.  Whether paying for performance improves CEO or firm performance remains a hotly contested issue, as does the payment of huge bonuses to traders and others in the Finance sector.

The second reason not to dismiss performance pay too lightly is that there are secular trends that should lead to more pay for performance. The first is skills-biased technological change (SBTC): this increases demand for highly skilled workers who should respond well to performance pay.  The second secular trend is the declining cost of monitoring workers, something that allows employers to identify performance against which performance pay can be determined.  A heavily cited paper in the literature (Lemieux et al., 2009) suggests these trends helped account for a growth in the use of performance pay in the United States through to the mid-1990s.

A third reason to be mindful of performance pay is that governments are eager to promote it.  This is most apparent in the UK at present in the public sector. As recent analysis of the Workplace Employment Relations Survey 2011 shows performance pay is still relatively uncommon among public servants. But government has been trialling it for some time among teachers and among administrators of taxation and the benefits system.  They are intent on linking more public servants’ pay to performance, even if they meet union opposition in doing so.

A final reason concerns a recognition of unintended consequences of performance pay.  Studies of performance pay across a range of instances caution that one must get the contract ‘right’ for performance pay to have the intended effects.  Emphasising quantity over quantity, overusing machinery, breakdowns in teamwork are all potential outcomes in performance pay jobs.  Newer research by Keith A. Bender indicates that performance pay can cause extra stress on the job and lead to poor health of workers. 

So what do we learn from the new studies in the Special Issue of the NIESR Review? First, Maury Gittleman and Brooks Pierce find there has been no substantial growth in performance pay in the last decade or so, despite SBTC and declining monitoring costs. This is true in the United States and, as we will show in a new paper shortly (Forth et al., forthcoming), it’s true for Britain. Second, Patrick O’Halloran finds unions in the United States are not in the business of blocking performance pay always and everywhere.  They want a good deal for their members, of course. Sometimes that can include pay for performance. This message might be of interest to governments interested in pursuing a performance pay reform agenda. Third, using historical data from the Depression of the 1920s and 1930s Bob Hart and J. Elizabeth Roberts show earnings from piece rates in engineering were pro-cyclical, thus mitigating employment losses during the Great Depression.  Perhaps there are lessons here for employers today?

Keith A. Bender http://www.abdn.ac.uk/business/disciplines/economics/profiles/kabender

Alex Bryson http://niesr.ac.uk/users/bryson

You may download the Special Issue Papers free of charge in the coming month from the web addresses below:

Performance Pay: Trends and Consequences Introduction Keith A. Bender and Alex Bryson National Institute Economic Review 2013;226 R1-R3

http://ner.sagepub.com/cgi/reprint/226/1/R1

How Prevalent is Performance-Related Pay in the United States? Current Incidence and Recent Trends Maury Gittleman and Brooks Pierce National Institute Economic Review 2013;226 R4-R16

http://ner.sagepub.com/cgi/content/abstract/226/1/R4

Industrial Composition, Methods of Compensation and Real Earnings in the Great Depression Robert A. Hart and J. Elizabeth Roberts National Institute Economic Review 2013;226 R17-R29

http://ner.sagepub.com/cgi/content/abstract/226/1/R17

Union Coverage, Membership and Performance-Related Pay: Are Piece Rates Different?

Patrick O’Halloran

National Institute Economic Review 2013;226 R30-R41

http://ner.sagepub.com/cgi/content/abstract/226/1/R30

Further reading

Bender, K. A. and Theodossiou, I. (forthcoming) “The Unintended Consequences of the Rat Race:  The Detrimental Effects of Performance Pay on Health” Oxford Economic Papers.

http://oep.oxfordjournals.org/content/early/2013/09/28/oep.gpt032.full

Bryson, A., Freeman, R., Lucifora, C., Pellizzari, M and Perotin, V. (2013) “Paying for Performance: Incentive Pay Schemes and Employees’ Financial Participation”, in T. Boeri, C. Lucifora and K. J. Murphy (eds.) Executive Remuneration and Employee Performance-related Pay: A Transatlantic Perspective, Oxford University Press

http://www.oxfordscholarship.com/view/10.1093/acprof:oso/9780199669806.001.0001/acprof-9780199669806-chapter-16?rskey=Xw9fwd&result=4&q=incentive%20system

http://cep.lse.ac.uk/pubs/download/dp1112.pdf

Forth, J., Bryson, A. and Stokes, L. (forthcoming) “Are Firms Paying More For Performance?”, NIESR mimeo

Lemieux, T., MacLeod, W. B., Parent, D. (2009) “Performance Pay and Wage Inequality” Quarterly Journal of Economics, 124 (1): 1–49

http://qje.oxfordjournals.org/content/124/1/1.abstract

van Wanrooy, B., Bewley, H., Bryson, A., Forth, J., Freeth, S., Stokes, L. and Wood, S. (2013) The 2011 Workplace Employment Relations Study First Findings, ESRC/ACAS/NIESR/DBIS https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/210103/13-1010-WERS-first-findings-report-third-edition-may-2013.pdf