Optimal incentive mix of performance pay and efficiency wage

Firms use a rich set of incentives including fixed wages, bonuses, threat of firing and promise of promotion. Yet, we do not have a theoretical understanding of how such a mix of incentives can arise. This paper aims to build a theoretical model which describes the incentive mix as the solution to an optimal contracting problem and provides broader testable implications. The basic model has a principal-agent relationship with unobservable effort. The integrative model includes the basic model and three building blocks: job-assignment, learning and human capital. The derived incentive mix is a consequence of the dual role of firing. It is both an incentive and a sorting decive. The model's predictions are tested on firm-level data from a large pharmaceutical company. The broader testable implications beyond the incentive mix are also confirmed by the data.

Layoffs as Part of an Optimal Incentive Mix: Theory and Evidence

Firms offer highly complex contracts to their employees. These contracts contain a mix of various incentives, such as fixed wages, bonuses, promise of promotion, and threat of firing. This paper aims at explaining the reason why this incentive- mix arises. In particular, the model focuses on why firms are combining promotions and bonuses with firing. The theoretical model proposed is a job-assignment model with heterogeneous employees. In this model the firm is concerned about job assignment, because the overall productivity of the firm depends upon the quality of the employees and their allocation to jobs. The model shows that firing has a dual role. Firing creates incentives for the employees, and it is used as a sorting device that allows the firm to improve workforce quality. Thus, quality-concerned firms might want to combine cost-efficient incentives such as promotions and bonuses with firing. To comply with the Gibbons and Waldman critique, a large set of the model’s broader predictions is stated explicitly and tested on the personnel records from a large pharmaceutical company. The model’s predictions are shown to be consistent with the data.personnel economics, incentive mix, layoffs.

Human Capital and Career Success: Evidence from Linked Employer-Employee Data

Denmark's registry data provide accurate and complete career history data along with detailed personal characteristics (e.g., education, gender, work experience, tenure and others) for the population of Danish workers longitudinally. By using such data from 1992 to 2002, we provide rigorous evidence for the first time for the population of workers in an entire economy (as opposed to case study evidence) on the effects of the nature and scope of human capital on career success (measured by appointments to top management). First, we confirm the beneficial effect of acquiring general human capital formally through schooling for career success, as well as the gender gap in career success rates. Second, broadening the scope of human capital by experiencing various occupations (becoming a generalist) is found to be advantageous for career success. Third, initial human capital earned through formal schooling and subsequent human capital obtained informally on the job are found to be complements in the production of career success. Fourth, though there is a large body of the literature on the relationship between firm-specific human capital and wages, the relative value of firm-specific human capital has been rarely studied in the context of career success. We find that it is more beneficial to broaden the breadth of human capital within the firm than without, pointing to the significance of firm-specific human capital for career success.human capital, career development, occupations, internal promotion, external recruitment, top management

Rising Wage Inequality: Does the Return to Management Tell the Whole Story?

This paper argues that the increased wage inequality observed in recent years is driven by changes in management compensation. The analysis is conducted within the framework of a two-sector search model with heterogeneous employees and heterogenous jobs i.e. employees with different educational levels who work in either management or the non-management sector of a firm. Individuals employed in the non-management sector search for management jobs while employed. This model characterizes the labor market flows, the firm’s structure and the employee composition as well as the wage distribution in the firm. Using the personnel records from a large pharmaceutical company, the parameters of the model are estimated. This allows us to conclude that the increased wage inequality observed is due to amplified within and between group wage inequality which is driven by an increased gap between management and non-management wages.wage inequality, two-sector search model, skill-based technological change, personnel data

Management Compensation and Firm-Level Income Inequality

In recent decades, most developed countries have experienced a simultaneous increase in income inequality and management compensation. In this paper, we study the relation between management compensation and firm-level income dynamics in a general equilibrium model. Empirical estimation, of the model’s key parameters show that the rising management premium is indeed the main driving force behind the observed increase in income inequality. This is the case even when other potential sources such as technological progress and skill-biased technological change are taken into account. We also show that a rising management premium produces income distribution dynamics at the firm level which are similar to those observed at the market level, i.e. rising income inequality overall as well as within and between education groups.income inequality, two-sector search model, skill-biased technological change, personnel data

Where did they go?

We study individual job-separations and their associated destination states for all individuals in the private sector in Denmark for the period 1980 to 1995 and account for the cyclical flows. We find that individual and workplace characteristics as well as business cycle effects are important in explaining the individual behaviour. In policy simulations we look at the impact on individual transitions. We find that structural and growth policies have different implications for the economy. Policy interventions with the purpose of preventing firm closures are argued to be inefficient.Business cycles; Job separations; Transition probabilities

Overtime work, dual job holding and taxation

Traditionally, labour supply data do not include much information on hours and wages in secondary job or overtime work. In this paper, we estimate labour supply models based on survey information on hours and wages in overtime work and second job which is merged to detailed register information on income taxes, deductions, taxable income etc. We also allow for the effect of observed fixed costs in main occupation and unobserved fixed costs in second job, and a ‘stigmatization effect’ from unemployment. The estimated models follow a ‘Hausman-approach’. The results indicate that the labour supply elasticities are highly sensitive to the inclusion of information on overtime work and secondary job and to the handling of fixed costs of work. The estimated elasticities are numerically larger when explicit information on overtime and second job work is taken into account compared to traditional labour supply models without explicit information on overtime pay and second job wages. However, when the model allows for stigmatization effects and unobserved fixed costs of work in second job, the resulting elasticities reduce considerably.Labour supply; Dual job holding; Overtime work; Piecewise linear budget constraints

Discrete Time Duration Models with Group-level Heterogeneity

Dynamic discrete choice panel data models have received a great deal of attention. In those models, the dynamics is usually handled by including the lagged outcome as an explanatory variable. In this paper we consider an alternative model in which the dynamics is handled by using the duration in the current state as a covariate. We propose estimators that allow for group specific effect in parametric and semiparametric versions of the model. The proposed method is illustrated by an empirical analysis of job durations allowing for firm level effects.Panel Data, Discrete Choice, Duration Models

What Do We Work For? An Anatomy of Pre- and Post-Tax Earnings Growth

Promotions and cross-firm mobility provide substantial gains in earnings – a well established finding based on gross income data. Yet, what matters for incentives is how much an individual can consume or save after taxation. We show that net and gross income growth patterns may differ substantially when a progressive tax system allows for deduction opportunities. Exploiting unique matched employer-employee data with information on tax payments and employee mobility, we find that gross income gains from promotions and cross-firm mobility do not translate into significantly higher net income growth, because employees adjust their tax-shielded consumption and savings (in particular, deductible private pension contributions and mortgage-financed housing) to maintain constant net income growth.earnings growth, promotions, mobility, taxable income, dynamic panel data models, matched employer-employee data