Firms' Choice of Method of Determining Pay: Evidence from the Industry Wage Surveys

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Monitoring the performance of workers is a costly and difficult procedure for many firms and, thus, the information about worker productivity is often very imperfect. While this fact is fairly obvious, the implications of this for the way in which workers are compensated is not. Because compensation schemes can have an enormous impact on worker productivity, the implications of worker compensation arrangements have been an important theme in labor economics and economic theory generally. The extent to which employers monitor workers and use what they learn from monitoring in setting wages is a topic which has been tackled from a number of theoretical perspectives. Of these, the literature on piece rates vs. salaries is closest to the framework developed in this study. In order to better reflect choices actually faced by firms, this project will extend this two-way choice situation to a three-way choice situation of piece rates, merit pay (which links wages to supervisory ratings) and standard rates (in which there is only a weak link between pay and performance). Within this framework, some of the key insights of the related principal-agent and efficiency-wage literature will be incorporated. This framework will be developed using data from the Industrial Wage Survey, the Census of Manufacturing and the Dictionary of Occupational Titles.