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Manpower Human Resource Lab paper

Performance Pay and Within-Firm Wage Inequality


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.


Erling Barth, Bernt Bratsberg, Torbjørn Hægeland and Oddbjørn Raaum

April 2008     Paper Number MHRLDP0007

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This Manpower Human Resource Lab paper is published under the centre's programme.