Performance related pay and individualised wage setting appears to be on the rise, even in economies with strong unions. Following the publication of the seminal article of Holmström and Milgrom (1987), performance-based pay became a predominant method of rewarding executive managers. But individualised pay and performance related pay appear to be spreading to lower ranks of employees within organisations, and throughout the labour market as well.
Particularly in Europe, where negotiated, fixed union wages has been the principle point of departure, this development represents an important break with traditional forms of remuneration. This paper analyses the effect of introducing performance related pay on the within-firm wage dispersion. In particular, our focus is on interaction effects between performance pay and collective bargaining.
Wage differences among workers with similar qualifications are on the rise as well. Autor et al (2005) conclude that increased within-group inequality accounts for the main part of the increase in the wage dispersion in the United States over the last 30 years. Barth et al. (2005), using comparable micro data from 15 European countries over 20 years, find evidence of similar trends in Europe.
The relative impact of demand and supply changes versus institutional factors on levels and trends in wage inequality across countries remains a debated question. Below, we examine the role of performance-related pay schemes in shaping the wage distribution. We analyse the effect of introducing performance related pay on the within-establishment, conditional wage dispersion, using a representative panel of two employer surveys from Norway, matched with the full set of employee records. Our data allows us to use a comprehensive set of controls, and furthermore to obtain identification by the use of fixed worker and firm effects. In particular, we may thus sweep out the effect of different sorting of workers across firms as well as firm specific heterogeneity, which are both a great concern in the analysis of the relationship between pay and remuneration schemes.
Unions compress wages. See eg. Freeman and Medoff (1984) and Card, Lemieux and Riddell (2004) for evidence. Dinardo, Fortin and Lemieux, (1996) find that a decline in unionism contributed to a considerable part of the increase in wage inequality in the US. Kahn (2000) argues that differences in collective coverage explain a large part of the observed differences in wage dispersion across countries. In this paper we analyse both theoretically and empirically the interaction effect of union bargaining and performance related pay. How does the introduction of performance related pay affect wage dispersion in non-union versus union bargaining environments? Does pay for performance offset the wage compressing effect of unions?
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