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Abstract:

CEP Discussion Paper
It's Not What You Pay
Sue Fernie and David Metcalf
May 1996
Paper No' CEPDP0295:

Management scholars and economists have recently set out the principles underlying the 'ideal' payment system to elicit good performance by aligning the interests of the principal and agent. Such a system involves an incentive contract, reputation and certain organizational arrangements. We analyze pay and performance in an occupation - jockeys - where the payment system for most individuals is congruent with the theoretical ideal. We are able to do this because, most unusually, a measure of pure individual performance exists for an unbalanced panel of some 50 individuals for eight years. Pay and performance go hand-in-hand and the sensitivity of changes in compensation to changes in performance is substantially larger than that found in many corresponding studies where the payment system is not ideal. By contrast, an alternative payment mechanism involving very large non-contingent payments for a few individuals does not generate good performance. Comparisons are also made with pay-performance relationships in other areas, including executive compensation. Our evidence suggests that 'it's not what you pay it's the way that you pay it...and that's what gets results.'