Performance Pay and Enterprise Productivity: The Details Matter

31 Pages Posted: 30 May 2018

See all articles by Takao Kato

Takao Kato

Colgate University - Economics Department; IZA Institute of Labor Economics

Antti Kauhanen

ETLA, Research Institute of the Finnish Economy

Abstract

Much of the empirical literature on PRP (Performance Related Pay) 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. In so doing we exploit the panel nature of our Finnish Linked Employer-Employee Data on the details of PRP.We first establish that the omitted variable bias is serious, 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, we find: (i) group incentive PRP is more potent in boosting enterprise productivity than individual incentive PRP; (ii) group incentive PRP with profitability as a performance measure is especially powerful in raising firm productivity; (iii) 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 (iv) 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.

Keywords: performance pay and productivity

JEL Classification: M52, J33, J24, J53, O53

Suggested Citation

Kato, Takao and Kauhanen, Antti, Performance Pay and Enterprise Productivity: The Details Matter. IZA Discussion Paper No. 11523, Available at SSRN: https://ssrn.com/abstract=3185215 or http://dx.doi.org/10.2139/ssrn.3185215

Takao Kato (Contact Author)

Colgate University - Economics Department ( email )

13 Oak Drive
Hamilton, NY 13346
United States
315-228-7562 (Phone)
315-228-7033 (Fax)

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Antti Kauhanen

ETLA, Research Institute of the Finnish Economy ( email )

Arkadiankatu 21B
Helsinki, 00100
Finland

HOME PAGE: http://staff.etla.fi/kauhanen/

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