Some Evidence on the Relationship between Performance-Related Pay and the Shape of the Experience-Earnings Profile

Abstract

We investigate the relationship between performance-related pay (PRP) and the shape of workers' experience-earnings profiles. In particular, we argue that the slope of the profile depends critically upon the degree of 'equity' held by workers in their enterprise as measured by the extent of PRP. The implication is that the slope of the profile for PRP workers falls between those of their zero-equity fixed-wage, and one hundred per cent equity self-employed, counterparts. Our empirical analysis of three British data sets, namely the British Social Attitudes Survey, the British Household Panel Survey, and the British Family Expenditure Survey, supports this prior. In this paper we explore the shape of the experience-earnings profile for individuals employed under different types of contracts: fixed-wage, performance-related pay (PRP), and self-employment contracts. We follow Lazear (1979, 1981) and Lazear and Moore (1984) in hypothesizing that the slope of the experience-earnings profile reflects agency costs, and the reduction thereof, with increased agency costs inducing steeper profiles. If monitoring costs are high, firms may implement compensation schemes designed to encourage employees to self-select behavior in the firms' interests. One such scheme defers a substantial amount of compensation until the later years of tenure. The resulting experience-earnings profile provides a penalty for shirking (Lazear and Moore 1984). We, therefore, presume that the profiles of workers employed under fixed-wage contracts are steeper than those of self-employees for whom the issue of agency does not arise because of the duality of principal and owner (Lazear and Moore 1984). The interesting case is that of workers employed under PRP. If such contracts represent a hybrid between fixed-wage and self-employment, then one would expect their experience-earnings profiles to lie somewhere between these two extreme