Pay and incentives

  • Articles

Equal pay legislation and the gender wage gap

Despite major efforts at equal pay legislation, gender pay inequality still exists in the developed economies. How can this be put right?

10.15185/izawol.16 16 Polachek, S

by Solomon W. Polachek

Despite equal pay legislation dating back 50 years, American women still earn 22% less than their male counterparts. In the UK, with its Equal Pay Act of 1970, and France, which legislated in 1972, the gap is 21% and 17% respectively, and in Australia it remains around 17%. Interestingly, the gender pay gap is relatively small for the young but increases as men and women grow older. Similarly, it is large when comparing married men and women, but smaller for singles. Just what can explain these wage patterns? And what can governments do to speed up wage convergence to close the gender pay gap? Clearly, the gender pay gap continues to be an important policy issue.

Do responsible employers attract responsible employees?

The cost of a firm’s commitment to CSR may be offset by its appeal to motivated employees who work harder for lower wages

10.15185/izawol.17 17 Nyborg, K

by Karine Nyborg

Survey and register data indicate that many employees prefer a socially responsible employer and will accept a lower wage to achieve this. Laboratory experiments support the hypothesis that socially responsible groups are more productive than others, partly because they attract cooperative types, partly because initial cooperation is reinforced by group dynamics. Overall, the findings indicate corporate social responsibility may have cost advantages for firms.

Efficient markets, managerial power, and CEO compensation

CEO pay, often contentious, is the product of many forces

10.15185/izawol.34 34 Bognanno, M

by Michael L. Bognanno

The escalation in chief executive officer (CEO) pay over recent decades, both in absolute terms and in relation to the earnings of production workers, has generated considerable attention. The pay of top executives has grown noticeably in relation to overall firm profitability. The pay gap between CEOs in the US and those in other developed countries narrowed substantially during the 2000s, making top executive pay an international concern. Researchers have taken positions on both sides of the debate over whether the level of CEO pay is economically justified or is the result of managerial power.

How should teams be formed and managed?

How teams are chosen and how they are compensated can determine how successfully they solve problems and benefit the firm

10.15185/izawol.83 83 Owan, H

by Hideo Owan

The keys to effective teamwork in firms are (1) carefully designed team-formation policies that take into account what level of diversity of skills, knowledge, and demographics is desirable and (2) balanced team-based incentives. Employers need to choose policies that maximize the gains from teamwork through task coordination, problem solving, peer monitoring, and peer learning. Unions and labor market regulations may facilitate or hinder firms’ attempts at introducing teams and team-based incentives.

Fairness and motivation

Fair treatment creates incentives, and is beneficial for workers and the firm

10.15185/izawol.9 9 Falk, A

by Armin Falk

How do firms motivate their employees to be productive? The conventional wisdom is that workers respond to monetary incentives—“Pay them more and they will work harder.” However, a large and growing body of empirical evidence from laboratory and field experiments, surveys, and observational data, as well as neuroeconomic research, suggests that workers’ perceptions of fairness and trust are also key drivers of their work effort. Treating employees with respect is not only ethically warranted, it can create positive economic outcomes for both the worker and the firm.

Market competition and executive pay

Increased competition affects the pay incentives firms provide to their managers and may also affect overall pay structures

10.15185/izawol.115 115 Ferreira, P

by Priscila Ferreira

Deregulation and managerial compensation are two important topics on the political and academic agenda. The former has been a significant policy recommendation in light of the negative effects associated with overly restrictive regulation on markets and the economy. The latter relates to the sharp increase in top executives’ pay and the nature of the link between pay and performance. To the extent that product-market competition can affect the incentive schemes offered by firms to their executives, the analysis of the effects of competition on the structure of compensation may be informative for policy purposes.

Are workers motivated by the greater good?

Workers care about employers’ social causes, but the public sector does not attract particularly motivated employees

10.15185/izawol.138 138 Tonin, M

by Mirco Tonin

Employees show more commitment to an employer that promotes the greater good, and they work harder too. Moreover, many people are willing to give up some of their compensation to contribute to a social cause. Being able to attract a motivated workforce would be particularly important for the public sector, but this goal remains elusive. Indeed, there is evidence for the public sector that paying people more or underlining the career opportunities (as opposed to the social aspects) associated with public sector jobs is instrumental in attracting a more productive workforce, without having a negative impact on intrinsic motivation.

Performance-related pay and labor productivity

Do pay incentives and financial participation schemes have an effect on a firm’s performance?

10.15185/izawol.152 152 Lucifora, C

by Claudio Lucifora

Many firms offer employees a remuneration package that links pay to performance as a means of motivation. It also improves efficiency and reduces turnover and absenteeism. The effects on productivity depend on the type of scheme employed (individual or group performance) and its design (commissions, piece-rate or sharing schemes). Individual incentives demonstrate the largest effect, while group or team incentives are smaller in magnitude. The case for government intervention through tax breaks and other financial incentives is highly debated due to differences across firms and the potential for economic inefficiencies.

How effective are financial incentives for teachers?

Linking teacher pay to student performance has become popular, but evidence on its effectiveness is mixed

10.15185/izawol.158 158 Imberman, S

by Scott A. Imberman

Concerns about poor student performance have led schools to diverge from traditional teacher compensation and base a portion of pay on student outcomes. In the US, the number of school districts adopting such performance-based financial incentives has increased by more than 40% since 2004. Evidence on individual incentives in developed countries is mixed, with some positive and some negligible impacts. There is less evidence for developing countries, but several studies indicate that incentives can be highly effective and far cheaper to implement. Innovative incentive mechanisms such as incentives based on relative student performance show promise.

High involvement management and employee well-being

Giving employees more discretion at work can boost their satisfaction and well-being

10.15185/izawol.171 171 Böckerman, P

by Petri Böckerman

A wide range of high involvement management practices, such as self-managed teams, incentive pay schemes, and employer-provided training have been shown to boost firms’ productivity and financial performance. However, less is known about whether these practices, which give employees more discretion and autonomy, also benefit employees. Recent empirical research that aims to account for employee self-selection into firms that apply these practices finds generally positive effects on employee health and other important aspects of well-being at work. However, the effects can differ in different institutional settings.

Goal setting and worker motivation

Individual work goals can increase a worker’s performance, but they need to be chosen wisely

10.15185/izawol.178 178 Goerg, S

by Sebastian J. Goerg

Employers want motivated and productive employees. Are there ways to increase employee motivation without relying solely on monetary incentives, such as pay-for-performance schemes? One tool that has shown promise in recent decades for improving worker performance is setting goals, whether they are assigned by management or self-chosen. Goals are powerful motivators for workers, with the potential for boosting productivity in an organization. However, if not chosen carefully or if used in unsuitable situations, goals can have undesired and harmful consequences. Goals are a powerful tool that needs to be applied with caution.

Should firms allow workers to choose their own wage?

Delegating the choice of wage setting to workers can lead to better outcomes for all involved parties

10.15185/izawol.223 223 Charness, G

by Gary B. Charness

Economists typically predict that people are inherently selfish; however, experimental evidence suggests that this is often not the case. In particular, delegating a choice (such as a wage) to the performing party may imbue this party with a sense of responsibility, leading to improved outcomes for both the delegating entity and the performing party. This strategy can be risky, as some people will still choose to act in a selfish manner, causing adverse consequences for productivity and earnings. An important issue to consider is therefore how to encourage a sense of responsibility in the performing party.

Profit sharing: Consequences for workers

Profit sharing, a formal “bonus” program based on firm profitability, can provide strong employee motivation if properly designed

10.15185/izawol.225 225 Fang, T

by Tony Fang

Profit sharing can lead to higher productivity and thus to higher firm profitability and employee wages. It may also enhance employment stability by enabling firms to adjust wages during downturns rather than lay off workers. While adoption of profit sharing increases earnings fluctuations, it also increases earnings growth in the longer term. As with any group incentive plan, profit sharing may result in some workers benefiting from the effort of others without themselves exerting greater effort (“free-rider problem”). However, there is evidence that in team-based production workplaces, profit sharing may reduce shirking and thus contribute to productivity growth.

Working-time autonomy as a management practice

Giving workers control over their working hours increases their commitment and benefits firm performance

10.15185/izawol.230 230 Beckmann, M

by Michael Beckmann

Allowing workers to control their work hours (working-time autonomy) is a controversial policy for worker empowerment, with concerns that range from increased shirking to excessive intensification of work. Empirical evidence, however, supports neither view. Recent studies find that working-time autonomy improves individual and firm performance without promoting overload or exhaustion from work. However, if working-time autonomy is incorporated into a system of family-friendly workplace practices, firms may benefit from the trade-off between (more) fringe benefits and (lower) wages but not from increased productivity.

Employee incentives: Bonuses or penalties?

Penalty contracts lead to higher productivity than performance-based bonuses, but at the cost of employer/staff relations

10.15185/izawol.234 234 Nosenzo, D

by Daniele Nosenzo

Firms regularly use incentives to motivate their employees to be more productive. However, often little attention is paid to the language used in employment contracts to describe these incentives. It may be more effective to present incentives as entitlements that can be lost by failing to reach a performance target, rather than as additional rewards that can be gained by reaching that target. However, emphasizing the potential losses incurred as a result of failure may entail hidden costs for the employer, as it may damage the trust relationship between a firm and its employees.

Gender differences in competitiveness

To what extent can different attitudes towards competition for men and women explain the gender gap in labor markets?

10.15185/izawol.236 236 Lackner, M

by Mario Lackner

Differences in labor market outcomes for women and men are highly persistent. Apart from discrimination, one frequently mentioned explanation could be differences in the attitude towards competition for both genders. Abundant empirical evidence indicates that multiple influences shape attitudes towards competition during different periods of the life cycle. Gender differences in competitiveness will not only influence outcomes during working age, but also during early childhood education. In order to reduce the gender gap in educational and labor market outcomes, it is crucial to understand when and why gender gaps in competitiveness arise and to study their consequences.

Internal hiring or external recruitment?

The efficacy of internal or external hiring hinges on other policies that a firm uses simultaneously

10.15185/izawol.237 237 DeVaro, J

by Jed DeVaro

Hiring is one of a firm’s most important decisions. When an employer fills a vacancy with one of its own workers (through promotion or lateral transfer), it forgoes the opportunity to fill the position with a new hire from outside the firm. Although both internal and external hiring methods are used, firms frequently have a bias favoring insiders. Internal and external hires differ in observable characteristics (such as skill levels), as do the employers making each type of hiring decision. Understanding those differences helps employers design and manage hiring policies that are appropriate for their organizations.

Incentives for prosocial activities

Economic incentives can motivate prosocial behavior, but may shift attention away from valuable altruistic activities

10.15185/izawol.238 238 Lacetera, N

by Nicola Lacetera

Early studies often found that offering economic incentives for undertaking prosocial and intrinsically motivated activities can crowd out motivation to perform these activities. More recent work highlights nuanced and important features related to whether crowding out (or substitution) is likely to occur. In many cases, incentives succeed in encouraging more prosocial behavior and are also cost-effective. However, although the substitution of external incentives for intrinsic motivation may not be a concern in many contexts, the substitution of one prosocial activity for another or shifts in activities over time or location may warrant further attention.

Are part-time workers less productive and underpaid?

The impact of part-time workers on firms’ productivity is unclear, and lower wages depend mainly on occupation and sector

10.15185/izawol.249 249 Garnero, A

by Andrea Garnero

About one in five workers across OECD countries is employed part-time, and the share has been steadily increasing since the beginning of the economic and financial crisis in 2007. Part-time options play an important economic role by providing more flexible working arrangements for both workers and firms. Part-time employment has also contributed substantially to increasing the employment rate, especially among women. However, part-time work comes at a cost of lower wages for workers, mainly because part-time jobs are concentrated in lower paying occupations and sectors, while the impact on firms’ productivity is still not very clear.

Gender differences in risk attitudes

Belief in the existence of gender differences in risk attitudes is stronger than the evidence supporting it

10.15185/izawol.100 100 Filippin, A

by Antonio Filippin

Many experimental studies and surveys have shown that women consistently display more risk-averse behavior than men when confronted with decisions involving risk. These differences in risk preferences, when combined with gender differences in other behavioral traits, such as fondness for competition, have been used to explain important phenomena in labor and financial markets. Recent evidence has challenged this consensus, however, finding gender differences in risk attitudes to be smaller than previously thought and showing greater heterogeneity of results depending on the method used to measure risk aversion.

Access to public transport and labor informality

Poor public transport can reduce employment in the formal sector

10.15185/izawol.274 274 Moreno-Monroy, A

by Ana I. Moreno-Monroy

Public transport infrastructure has not kept up with the demands of growing populations in cities in developing countries. Infrastructure provision has historically been biased against less affluent areas, so access to formal jobs is often difficult and costly for a large part of the lower-income population. As a result, low-income workers may be discouraged from commuting to formal jobs, lack information on job opportunities, and face discrimination. Through these channels, constrained accessibility can result in higher rates of job informality. Reducing informality can be a target for well-designed transport policies.

Efficiency wages: Variants and implications

Wages affect productivity and non-wage costs; this carries important labor market and policy implications

10.15185/izawol.275 274 Schlicht, E

by Ekkehart Schlicht

Higher wages increase labor costs but also improve the productivity of the labor force in several ways. If firms take this into account and set their wages accordingly, the resulting wages could fail to adjust demand and supply but may induce phenomena like over-education, discrimination, regional wage differentials, and a tendency for larger firms to pay higher wages. All these phenomena are quantitatively important and well-established empirically. Efficiency wage theory provides an integrated theoretical explanation rather than a sundry list of reasons, and offers an efficiency argument for progressive income taxation.

Does government spending crowd out voluntary labor and donations?

There is little evidence that government spending crowds out private charitable donations of time and money

10.15185/izawol.299 299 Bredtmann, J

by Julia Bredtmann

Private charitable contributions play an essential role in most economies. Despite the existence of welfare states, people contribute money and supply volunteer labor to charity. From a policy perspective, there is concern that comprehensive government spending might crowd out these private charitable donations. If perfect crowding out occurs, then every dollar spent by the government will lead to a one-for-one decrease in private spending, leaving the total level of welfare unaltered. Understanding the magnitude and causes of crowding out is crucial, as it represents a hidden cost to public spending and can thus have significant impacts on public welfare.

The pros and cons of workplace tournaments

Tournaments can outperform other compensation schemes such as piece-rate and fixed wage contracts

10.15185/izawol.302 302 Sheremeta, R

by Roman M. Sheremeta

Tournaments are commonly used in the workplace to determine promotion, assign bonuses, and motivate personal development. Tournament-based contracts can be very effective in eliciting high effort, often outperforming other compensation contracts, but they can also have negative consequences for both managers and workers. The benefits and disadvantages of workplace tournaments have been identified in an explosion of theoretical, empirical, and experimental research over the past 30 years. Based on these findings, suggestions and guidelines can be provided for when it might be beneficial to use tournaments in the workplace.

Gender wage discrimination

Does the extent of competition in labor markets explain why female workers are paid less than men?

10.15185/izawol.310 310 Hirsch, B

by Boris Hirsch

There are pronounced and persistent wage differences between men and women in all parts of the world. A significant element of these wage disparities can be attributed to differences in worker and workplace characteristics, which are likely to mirror differences in worker productivity. However, a large part of these differences remains unexplained, and it is common to attribute them to discrimination by the employer that is rooted in prejudice against female workers. Yet recent empirical evidence suggests that, to a large extent, the gaps reflect “monopsonistic” wage discrimination—that is, employers exploiting their wage-setting power over women—rather than any sort of prejudice.

Can lab experiments help design personnel policies?

Employers can use laboratory experiments to structure payment policies and incentive schemes

10.15185/izawol.318 318 Villeval, M

by Marie Claire Villeval

Can a company attract a different type of employee by changing its compensation scheme? Is it sufficient to pay more to increase employees’ motivation? Should a firm provide evaluation feedback to employees based on their absolute or their relative performance? Laboratory experiments can help address these questions by identifying the causal impact of variations in personnel policy on employees’ productivity and mobility. Although they are collected in an artificial environment, the qualitative external validity of findings from the lab is now well recognized.

Does employee ownership improve performance?

Employee ownership generally increases firm performance and worker outcomes

10.15185/izawol.311 311 Kruse, D

by Douglas Kruse

Employee ownership has attracted growing attention for its potential to improve economic outcomes for companies, workers, and the economy in general, and help reduce inequality. Over 100 studies across many countries indicate that employee ownership is generally linked to better productivity, pay, job stability, and firm survival—though the effects are dispersed and causation is difficult to firmly establish. Free-riding often appears to be overcome by worker co-monitoring and reciprocity. Financial risk is an important concern but is generally minimized by higher pay and job stability among employee owners.

Are happy workers more productive?

Firms’ concerns about the well-being of their employees are largely supported by the evidence

10.15185/izawol.315 315 Proto, E

by Eugenio Proto

Recently, large companies like Google have made substantial investments in the well-being of their workers. While evidence shows that better performing companies have happier employees, there has been much less research on whether happy employees contribute to better company performance. Finding causal relations between employee well-being and company performance is important for firms to justify spending corporate resources to provide a happier work environment for their employees. While correlational and laboratory studies do find a positive relationship, the evidence remains sparse.

Inequality and informality in transition and emerging countries

Higher inequality decreases capital accumulation and increases informality, which, in turn, raises the income of the poor

10.15185/izawol.325 325 Dell'Anno, R

by Roberto Dell'Anno

Higher inequality reduces capital accumulation and increases the informal economy, which creates additional employment opportunities for low-skilled and deprived people. Despite this positive feedback, informality raises problems for public finances and biases official statistics, reducing the effectiveness of redistributive policies. Policymakers should consider the links between inequality and informality because badly designed informality-reducing policies may increase inequality. However, convincing empirical evidence is still lacking and is usually limited to correlations rather than causal effects.

Are overhead costs a good guide for charitable giving?

Donors rely on overhead costs to evaluate charities, but that reliance creates disincentives for charities to hire skilled workers

10.15185/izawol.329 329 Meer, J

by Jonathan Meer

Charity rating agencies often focus on overhead cost ratios in evaluating charities, and donors appear to be sensitive to these measures when deciding where to donate. Yet, there appears to be a tenuous connection between this widely-used metric and a charity’s effectiveness. There is evidence that a focus on overhead costs leads charities to underinvest in important functions, especially skilled workers. To evaluate policies that regulate overhead costs, it is necessary to examine whether donors care about overhead costs, whether they are good measures of charity effectiveness, and what effects a focus on overhead costs has on charities.

Can firms oversee more workers with fewer managers?

Firms need to tailor their allocation of talent and responsibility, and their managerial structure, to fit their competitive situation

10.15185/izawol.333 333 Smeets, V

by Valerie Smeets

Managers are supervising more and more workers, and firms are getting flatter. However, not all firms have been keen on increasing the number of subordinates that their bosses manage (referred to as the “span of control” in human resource management), contending that there are limits to leveraging managerial ability. The diversity of firms’ organizational structure suggests that no universal rule can be applied. Identifying the factors behind the choice of firms’ internal organization is crucial and will help firms properly design their hierarchy and efficiently allocate scarce managerial resources within the organization.