Pay for Performance

1
Pay for Performance
2
Piece Rates

• Piece rates are compensation paid in proportion
  to the number of units of output.
• Piece rates limit the amount of shirking.
• Drawbacks
• May be difficult to set rate.
• They increase income variability and so firms
  will have to pay a premium.
• Difficult to use where team production is
  employed.
• Workers may decrease quality.

3
Commissions and Royalties

• Commissions and royalties are compensation paid
  in proportion to the value of sales.
• These are efficient where work effort is
  difficult to observe.
• Authors, sales people, recording artists

4
Bonuses

• Bonuses are payments beyond the annual salary
  based on some factor such as personal or firm
  performance.
• Elicit extra work effort and are not permanent
  costs.
• Personal performance bonuses
• Based on evaluation by superiors or quantifiable
  measure.
• May have unintended effects.
• Workers schmooze superiors.

5
Bonuses

• Team performance bonuses
• Based on team performance.
• Leads to the free-rider problem.
• Workers have less incentive to work hard as the
  size of the group rises since their own effort
  matters less.
• Team performance bonuses work best when the size
  of the group is small.

6
Profit Sharing

• Profit sharing is a pay system that allocates a
  portion of the firms profits to its employees.
• In 1997, 16 were in a profit sharing plan.
• Supporters argue that profit sharing gives
  workers the incentive to work harder to increase
  firm profits.
• Critics argue that it suffers from the free-rider
  problem.
• Evidence indicates a modest positive effect on
  productivity.

7
Tournament Pay

• Tournament pay plans base compensation on
  relative performance.
• A large prize exists for top performer, smaller
  prize for second place, and so on.
• Encourages all participants to exert more
  effort.
• The CEO position may be first place in a
  tournament.
• CEOs are paid more than their personal MRP, but
  other executives increase their MRP in hopes of
  getting the top prize.

8
Highest Paid CEOs, 1999

9
Tournament Pay and CEOs

• Implications
• Managers who dont quite make it to CEO will also
  be paid more than their MRP.
• Golden parachute provisions in executive
  contracts provide protection against losing the
  full amount of CEO prize in takeover.
• Tenure in CEO position is short because firms
  need to provide openings for others.

10
Tournament Pay and CEOs

• Criticisms
• May not be optimal since participants may
  sabotage anothers performance.
• Pay may because executives determine the pay of
  other executives by serving on the corporate
  boards of other firms.