Piece Rate vs. Time Rate: The Effect of Incentives on Earnings

Abstract

This paper presents a detailed examination of the effect of piece rates and other forms of incentive compensation on individual employee earnings. The study examines the impact of incentives on the earnings of over 100,000 employees in 500 firms within the footwear and men's and boys' clothing industries. Two distinct incentive effects are observed. First, incentive workers' earnings are more disperse than identical time workers' earnings within both firms and occupations. This greater variance is maintained with the addition of controls for heterogeneity of individual characteristics between the two sectors. Second, incentive workers receive an earnings premium, in part to compensate for the greater variation in their income, and partially as a result of an incentive- effort effect. The incentive earnings premium averages 14%, controlling for individual characteristics, occupational classification, and individual firms. Subsequent decomposition of the incentive-earnings premium reveals that the compensating differential for variation in earnings accounts for a minority of the incentive earnings premium. This supports the view that increased effort by incentive employees leads to relatively greater earnings.