The Determinants of Performance-Pay Utilization by Firms and Its Consequences for Firm Behavior, Performance and Employee Outcomes
Early Career Research Grant
Performance pay is a classic economic tool to align incentives of worker and employers, yet the widespread adoption of such pay schemes has led to two concerns. First, growth in such schemes may have been driven by rent extraction rather than profit maximization. Second, there is little evidence as to whether performance pay provides the intended productivity benefits. This paper uses a natural experiment to address both questions. Our study exploits a UK tax reform that introduced tax advantages for firms that use employee share option schemes. We plan to leverage eligibility thresholds and compare nearly identical firms facing different costs of using such incentive schemes. In a first step, we test how much the utilization of performance pay responds to changes in the returns of such schemes. Second, we test if these incentive schemes improve firm outcomes. We study both traditional profit metrics, as well as effects on the distribution of returns within the firm. Our project will combine administrative tax data with data on incentive scheme use and exploit quasi-experimental variation in rules that determine tax exemptions to identify the causal effect of performance pay on firm-level outcomes.