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Performance pay and enterprise productivity: the details matter

Takao Kato (Department of Economics, Colgate University, Hamilton, New York, USA)
Antti Kauhanen (The Research Institute of the Finnish Economy, Helsinki, Finland)

Journal of Participation and Employee Ownership

ISSN: 2514-7641

Article publication date: 19 July 2018

Issue publication date: 7 August 2018

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Abstract

Purpose

The purpose of this paper is to provide novel and rigorous evidence on the productivity effect of varying attributes of performance-related pay (PRP) and shows that the details of PRP indeed matter.

Design/methodology/approach

In doing so, the authors exploit the panel nature of the Finnish Linked Employer–Employee Data on the details of PRP.

Findings

The authors first establish that the omitted variable bias is serious, which makes the cross-sectional estimates on the productivity effect of the details of PRP biased upward substantially. Relying on the fixed effect estimates that account for such bias, the authors find: (first, group incentive PRP is more potent in boosting enterprise productivity than individual incentive PRP; second, group incentive PRP with profitability as a performance measure is especially powerful in raising firm productivity; third, when a narrow measure (such as cost reduction) is already used, adding another narrow measure (such as quality improvement) yields no additional productivity gain; and fourth, PRP with greater power of incentives (the share of PRP in total compensation) results in greater productivity gains, and returns to power of incentives diminishes very slowly.

Originality/value

Much of the empirical literature on PRP focuses on a question of whether the firm can increase firm performance in general and enterprise productivity in particular by introducing PRP and if so, how much. However, not all PRP programs are created equal and PRP programs vary significantly in a variety of attributes. This paper provides novel and rigorous evidence on the productivity effect of varying attributes of PRP and shows that the details of PRP indeed matter.

Keywords

Acknowledgements

The authors are grateful for support from the Finnish Funding Agency for Technology and Innovation (Tekes). The paper benefited greatly from the comments by Richard Freeman and Andrew Pendleton, and other participants in the Mid-Year Fellows Workshop in Honor of Louis O. Kelso at Rutgers University, School of Management and Labor Relations, New Brunswick, New Jersey, USA. The research was also facilitated by Kato’s visit to the Research Institute of the Finnish Economy (ETLA), and Kato is grateful for their hospitality.

Citation

Kato, T. and Kauhanen, A. (2018), "Performance pay and enterprise productivity: the details matter", Journal of Participation and Employee Ownership, Vol. 1 No. 1, pp. 61-73. https://doi.org/10.1108/JPEO-03-2018-0013

Publisher

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Emerald Publishing Limited

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