Pay for performance and wage inequality

Lemieux, MacLeod, and Parent get to the point:

We document that an increasing fraction of jobs in the U.S. labor
market explicitly pay workers for their performance using bonuses,
commissions, or piece-rates.  We find that compensation in
performance-pay jobs is more closely tied to both observed (by the
econometrician) and unobserved productive characteristics of workers. 
Moreover, the growing incidence of performance-pay can explain 24
percent of the growth in the variance of male wages between the late
1970s and the early 1990s, and accounts for nearly all of the top-end
growth in wage dispersion (above the 80th percentile).

Here is the link, here is a non-gated version.  It is perhaps simplistic to say the people at the top now earn more because they can, but simplistic is not the same as wrong.  For me the puzzle is why the world held back so much on bonus pay for so long. 

Comments

"For me the puzzle is why the world held back so much on bonus pay for so long. "

Well, from my personal experiences, I'd tell you to look at something marginal, the marginal tax rates. Bonuses were great, until you realized you have to pay income and payroll taxes. A good chunk of your bonus goes to the government. Maybe you jump up a tax bracket thanks to the bonus, so more of it goes away.

Most companies don't handle the taxes on the bonus properly, so you wind up owing federal or state taxing money at the end of the year. Or, your tax planning for the year gets all screwed up because you planned on earning $X and instead earned 1.1 * $X (10% bonus, as an example).

Maybe improved accounting software is the cause for increases in bonuses.

"the puzzle is why the world held back so much on bonus pay for so long"

Reduction of unionization?

"MIAMI -- A teachers union went to court Friday to challenge the state's pioneering bonus-pay program..."

http://www.washingtonpost.com/wp-dyn/content/article/2007/01/12/AR2007011201562.html

I'm a libertarian. I commend incentive based salaries. Incentive based salaries not only help the stars of our economy, but those at the bottom of the pyramid by reducing prices.

Still, most people in this country are not libertarians. I'm afraid some sort of backlash might emerge. obama worries me.

"For me the puzzle is why the world held back so much on bonus pay for so long."

In most cases the performance and therefore of the bonus depends on things that are not completely under the control of the employee, so it makes the pay risky. A company will have higher average employment cost if they they offer compensation that is risky because most employees are risk adverse about their income.Only if a job shows a substantial effect of pay incentives would the company to offer a high bonus.
The effect of two earner families would decrease the extra average employee cost to the company. A 50% probability of earning either $10,000 or $90,000 is seen as much less valuable than a sure $50,000 or even $40,000. If however your spouse is earning a steady income of $50,000 the choice is then a 50% chance of $60,000 or $140,000 and you might take it in preference to a sure $90,000.

So that's what Hall-of-Fame hockey players do after they retire. They become economists! (Although I don't know who that MacLeod guy played for.)

Sorry, couldn't resist! ;)

Have performance bonuses really gone up? Or did they used to take other, non-cash forms?
Did the high performing executive of yesteryear get a vice-president ship or a cute secretary to take on all-expenses business trips?

If so, the VP position is much less secure now, as corporate restructuring and takeovers mean that a VP is only secure for a year or two. Hence it isn't really that great a reward anymore, cold hard cash is preferrable.

And obviously the cute "secretary" is right out these days.

So maybe the extra pay is appearing in the figures because previous methods have been rendered worthless.

The good ole boy fascist bloc of the Supreme Court doing what it does best:

http://www.nytimes.com/2007/05/30/washington/30scotus.html?hp

Again, major lack of transparency.

TC: "For me the puzzle is why the world held back so much on bonus pay for so long."

Joan: "In most cases the performance and therefore of the bonus depends on things that are not completely under the control of the employee, so it makes the pay risky."

It also makes it potentially unfair, and it will often have the same problem that I claim tipping has: that it poisons the relationship between the benefactor and the recipient. The more arbitrary the performance bonuses are (for instance, if they are given on a principal's "qualitative evaluation"), the more demeaning they are for the recipient. It's payment for a service after the service is already given - closer to begging for scraps at the table than an exchange between equals.

However, if bonuses are tied to some external indicator of quality, they have their own troubles, because these indicator are rarely completely dependent on what they are supposed to measure. Teachers may pursue cramming rather than promoting understanding, CEOs may make short-term decisions or even use illegal means to inflate their share prices.

There was one "armchair economist" here who stated that the basic fact of economics is that people respond to incentives. Well, it seems to me that is either trivially true (if you by incentives mean anything people respond to) or dangerous oversimplification (if you only think of performance bonuses and such).

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