May 19, 2015

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

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

Empirical research shows that:

  • Rewarding workers financially for good performance increases motivation, effort, and loyalty to the company
  • Personal rather than group reward schemes are most effective at boosting firm performance
  • Share-ownership schemes increase long-term firm performance

In a new article published today on IZA World of Labor, Claudio Lucifora writes that performance-related pay (PRP) increases worker productivity, which comes as no surprise. What’s new is that Lucifora finds that the financial incentives with maximum effect upon employee and firm success are schemes which reward individual performance rather than group performance.

So, are performance-related pay models a tool for rewarding a firm’s most productive employees, or a system loophole for paying workers minimal salaries without repercussions?

Some employees are highly incentivized to earn more for the company and themselves by personal PRP rewards, but less motivated by financial rewards delivered only if a group succeeds. Other more risk-averse workers prefer flat-rate salaries in place of any bonus scheme, and may suffer from psychological issues as they try, and potentially fail, to qualify for the performance-related payouts. PRP acts as a method for firms to detect and retain their best employees, but care needs to be taken with those employees struggling to survive in a workplace so driven by individual performance.

Lucifora comments: “An important question for both firms and policymakers is whether linking some elements of the pay scheme of employees to their individual performance has a direct and beneficial effect on productivity. The evidence presented in this paper shows that it does. PRP schemes are shown to be associated with higher employee productivity and better worker–firm match.”

Performance-related pay and labor productivity, by Claudio Lucifora publishes on May 19, 2015.

IZA World of Labor is a free, online resource created by the Institute for the Study of Labor (IZA) in collaboration with Bloomsbury Publishing Plc. Articles focus on global labor economics issues, drawing on empirical, evidence-based research in order to offer pertinent comment and evaluation, and best-practice policy advice.

Claudio Lucifora is Professor of Economics at the Università Cattolica in Milan. He has been elected member of the executive committee and Treasurer of European Association of Labor Economists, and his main research interests are in the field of labor economics, economics of education and health economics. He joined IZA as a Research Fellow in April 2003.