key topic

Pay and incentives

Workers are generally paid a salary (or wage) as a fixed amount in exchange for their services. However, they may also receive incentive pay, a monetary gift based on their performance. Incentive pay is thought of as one way to entice an employee to continue delivering positive results and may come in the form of a bonus, profit sharing, or commission.

  • Production spillovers: Are they valued?

    Spillovers can contribute to team success, although workers are not compensated for them

    Joseph Price, August 2017
    Workers can contribute to total firm production directly through their own output or indirectly through their influence on the output of co-workers. Workers with positive productivity spillover effects cause individuals around them to perform better and increase overall team production. In contrast to the “peer effects” literature, workers with positive productivity spillovers may not be the workers with the highest levels of personal output. Such productivity spillovers are important for team success even though they play only a minor role in determining worker pay.
  • Relative pay, effort, and labor supply

    Comparisons to others’ pay and to one’s own past earnings can affect willingness to work and effort on the job

    Anat Bracha, June 2017
    Recent studies show that even irrelevant relative pay information—earnings compared to the past or to others—significantly affects workers’ willingness to work (labor supply) and effort. This effect stems mainly from those whose pay compares unfavorably; accordingly, earning less compared to others or less than in the past significantly reduces one’s willingness to work and effort exerted on the job. Comparing favorably, however, has mixed effects—with usually no effect on effort, but positive or no effects on labor supply. Understanding when relative pay increases labor supply and effort can thus help firms devise optimal payment structures.
  • Does employee ownership improve performance?

    Employee ownership generally increases firm performance and worker outcomes

    Douglas Kruse, December 2016
    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.
  • Can lab experiments help design personnel policies?

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

    Marie Claire Villeval, November 2016
    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.
  • Efficiency wages: Variants and implications

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

    Ekkehart Schlicht, July 2016
    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.
  • 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

    Gary B. Charness, January 2016
    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.
show more