Contract Form, Wage Flexibility, and Employment

Abstract

We begin with two uncontroversial hypotheses - firm productivity is expensive to measure and employment entails relationship-specific investments. These assumptions imply that firms would optimally choose fixed-wage contracts, and complement these with bonus pay when measuring employee performance is not too costly. These assumptions imply that under an optimal employment contract hours of work is less responsive, while total compensation is more responsive to shocks under bonus-pay contracts compared to fixed wage contracts. Using data from the Panel Study of Income Dynamics (PSID) where shocks are proxied using the local unemployment rate, we find strong support for these two implications.

Who Fared Better? The Fortunes of Performance Pay and Fixed Pay Workers through Recession

“…An alternative perspective is obtained by considering the impact of regional or industry specific shocks. Lemieux et al (2012), using the US Panel Study of Income Dynamics, find that while wages of performance pay workers fall in response to adverse local labour market shocks (proxied by an increase in the local unemployment rate), those of fixed pay workers do not. Furthermore, such shocks lead to a reduction in hours worked for fixed pay workers, while hours worked by performance pay workers are unaffected.…”

“…If we focus on receipt of performance pay alone, we are likely to underestimate the prevalence of performance pay jobs, particularly during a downturn. To explore wage flexibility among employees in performance pay and non-performance pay jobs, we therefore make use of information in ASHE that allows us to identify performance pay jobs, following the work of Lemieux et al (2009) for the United States (see the Appendix for details). The resulting estimates of performance pay jobs are presented in Figure 1.…”

“…We then define an employee as remaining in the same job from one year to the next where that employee: (i) works for the same employer (identified using the IDBR enterprise reference number); (ii) has remained in the same job according to the employer's response in the survey and (iii) has remained within the same four-digit occupation (using the Standard Occupational Classification). 7 Following the work of Lemieux et al (2009) for the United States, we then identify performance pay jobs as those in which performance pay has been paid in any of the years in which we observe that job. Our definition of a job match differs from that used by Lemieux et al (2009), in that their job match is effectively an 'employer match', i.e.…”

“…7 Following the work of Lemieux et al (2009) for the United States, we then identify performance pay jobs as those in which performance pay has been paid in any of the years in which we observe that job. Our definition of a job match differs from that used by Lemieux et al (2009), in that their job match is effectively an 'employer match', i.e. the spell an individual spends…”

Don't Forget the Gravy! Are Bonuses Just Added on Top of Salaries?

“… Lemeuix, MacLeod, and Parent () use the Panel Study of Income Dynamics (PSID) to estimate the influence of a dichotomous bonus receipt indicator on an earnings variable that likely includes the value of bonuses. They find a small positive influence.…”