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Abstract:

Manpower Human Resource Lab Paper
Performance Pay and Within-Firm Wage Inequality
Erling Barth, Bernt Bratsberg, Torbjørn Hægeland and Oddbjørn Raaum
April 2008
Paper No' MHRLDP0007:
Full Paper (pdf)

JEL Classification: J31; J33


Tags: performance related pay; wage inequality; union bargaining

This paper examines the impact of performance-related pay on wage differentials within firms. Our theoretical framework predicts that, compared to a fixed pay system, pay schemes based on individual effort increase within-firm wage inequality, while group-based bonuses have minor effects on wage dispersion. Theory also predicts an interaction between performance-related pay and union bargaining, where union power reduces the impact of performance pay on wage dispersion. The empirical contribution utilizes two recent Norwegian employer surveys, linked to a full set of employee records. A longitudinal sub-sample allows for identification based on fixed establishment effects. Introduction of performance-related pay is shown to raise residual wage inequality in nonunion firms, but not in firms with high union density. Our findings suggest that even though performance-related pay appears to be on the rise, the overall impact on wage dispersion is likely to be small, particularly in European countries with strong unions.