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September 12, 2016

Do employees profit from profit sharing?

Opinion image

Profit sharing, a formal bonus program based on profitability, has a long history and is a practice that many firms continue to adopt. Recently, there has been considerable debate about whether employees benefit financially from it and similar practices. While some economists argue that profit sharing increases employee earnings, others contend that the effect is neutral, or even reduces earnings. Evidence is also mixed on whether profit sharing improves productivity. One important factor that has been much discussed, but rarely tested, is how team-based production affects the impacts of profit sharing.

As I discuss in my recent World of Labor article, our empirical analysis of Canada’s Workplace and Employee Survey shows that profit sharing can indeed deliver significant benefits to employees, through higher earnings and employment stability; and also to their employers, through higher productivity (Long and Fang, 2015).

Our results are consistent with the idea that organizations with a high investment in human capital will use profit sharing as a means to enhance the financial rewards to their employees. If a firm can attract and retain high-quality employees, that may translate into productivity improvements over time that, in turn, make it more feasible for firms to offer above-market compensation in the form of profit-sharing bonuses.

Profit sharing may be a particularly good fit for high-wage firms, given their need to protect and exploit their investment in human capital, while also minimizing their vulnerability to fluctuations in the market. At the same time, employees with higher wages are likely to be more comfortable with the risk engendered by profit sharing, as they are more able to afford it. They may well buy into the idea that a profit-sharing scheme gives their firm the flexibility to offer better than average compensation. Indeed, our research shows that the most important determinant of profit-sharing adoption is whether a firm already pays high wages.

Using the same database, our study also finds that team-based production is important to the success of employee profit sharing—at least for productivity. Of the organizations that adopted profit sharing, those with team-based production showed a highly significant increase in workplace productivity, while those without team-based production showed no significant increase. These findings are in line with the notion that working in teams prevents some shirking behavior at profit-sharing firms, and are an effective mechanism for transforming the purported motivational and other benefits of profit sharing into tangible gains.

In terms of the effects on employee attitudes and behaviors, there is also a small body of research pointing to positive effects on absenteeism, resignations, and organizational citizenship. However, more study is needed of these issues, and also the effects of profit sharing on job satisfaction.

So, profit sharing benefits both employees in terms of earnings and job stability, and their employers in terms of productivity (in turn allowing them to pay more). At the same time, by making employee earnings more responsive to financial circumstances, employers may be able to better manage their costs in poor economic times, making profit sharing a win–win for both employees and employers. Workers and unions may want to collaborate with management to enhance the mutual benefits of profit sharing. Governments, meanwhile, could incentivize profit sharing, perhaps by providing deferred tax benefits.

References:
Long, R. J., and T. Fang. "Do strategic factors affect adoption of profit sharing? Longitudinal evidence from Canada." International Journal of Human Resource Management 26:7 (2015): 971–1001.

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We recognize that IZA World of Labor articles may prompt discussion and possibly controversy. Opinion pieces, such as the one above, capture ideas and debates concisely, and anchor them with real-world examples. Opinions stated here do not necessarily reflect those of the IZA.