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