The Response of Worker Effort to Piece Rates.(Statistical Data Included)

Evidence from the British Columbia Tree-Planting Industry

ABSTRACT

We measure the elasticity of worker effort with respect to changes in the piece rate using panel data collected from the payroll records of a British Columbia tree-planting firm. Our data contain information on daily worker productivity and the piece rate received over a five-month period. Using a structural model to control for the endogeneity of the piece rate, we estimate this elasticity to be approximately 2.14. We also calculate a nonstructural lower bound to this elasticity equal to 0.77. Structural estimation also allows us to perform policy experiments and to compare firm profits under alternative compensation systems. Our results suggest that profits would increase by at least 17 percent were the firm to implement the optimal static contract as predicted by principal-agent theory. This increase in profits would be due to capturing worker rents after the revelation of private information over ability. Yet, only a negligible proportion of these rents could be captured while inducing workers to reveal a bility truthfully, suggesting that dynamic considerations were important in determining the firm's actual choice of contract.

I. Introduction and Motivation

The role of economic incentives in determining behavior is of major interest to economists. Within the domain of labor economics, much theoretical attention has been focused on the optimal form of contracts between the firm and its workers (see, for example, Hart and Holmstrom 1987; Holmstrom and Milgrom 1990; and Baker 1992). The ability of labor contracts to affect worker productivity can also be applied to the analysis of personnel policies within the firm (as in Milgrom and Roberts 1992 and Lazear 1998). Some economists (for example, Blinder 1990) have further argued that the increase in worker productivity in response to the widespread adoption of performance-based pay would result in macroeconomic benefits. [1] For normative policy prescriptions to be valuable, however, they must be based on empirical analyses of the benefits accruing to changes in compensation systems. Empirically analyzing compensation policies and evaluating these benefits require measuring incentive effects; that is, how workers re act to changes in their economic incentives.

In the past, empirical work concerning incentive models has typically involved cross-sectional or longitudinal comparisons of wages among workers who do and do not receive incentive pay (see, for example, Pencavel 1977; Seiler 1984; Parent 1997; and Booth and Frank 1997). The strength of this approach is that it is based on a wide sample of observations from different sectors of the economy and therefore provides "general" results. Yet, whereas the results of these studies are usually consistent with incentive models (thus supporting the existence of incentive effects), problems exist with their interpretation. In particular, workers who do not receive explicit incentive pay may be provided with incentives through other mechanisms, such as the promise of future promotions (as in Lazear and Rosen 1981 or Goldin 1986) or termination contracts (as in Shapiro and Stiglitz 1984 or Macleod and Malcolmson 1989). This inability to document and to understand fully the personnel policies implemented by different firms in a cross section of data makes it difficult to identify incentive effects using these methods.

An alternative approach is to concentrate on industry- or firm-level data. Such an approach combines elements of the traditional case-study methodology, once popular in the industrial organization literature (see, for example, Wallace 1937), with econometric estimation. Examples of this approach can be found in the recent work of Ferrall and Shearer (forthcoming), Shearer (1996), Lazear (1996), Paarsch and Shearer (forthcoming), and Treble (1996). Within this approach, the detailed study of the personnel policies of the firm or firms in question yields knowledge of the incentive system determining worker behavior. Measuring worker reaction to variation in the compensation system then permits identification of incentive effects. Furthermore, access to firm archives often yields direct measures of worker productivity, so the presence or absence of incentive effects does not have to be inferred indirectly through a comparison of wages.