What Makes Performance-Related Pay Schemes Work? Finnish Evidence
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Ó Springer 2006
What Makes Performance-Related Pay Schemes Work? Finnish Evidence ANTTI KAUHANEN1,* and HANNU PIEKKOLA2 1 Department of Economics, Helsinki School of Economics, and HECER, P.O. Box 1210, FIN-00101, Helsinki, Finland (*Author for correspondence, e-mail: antti.kauhanen@hkkk.fi); 2 The Research Institute of the Finnish Economy, Lo¨nnrotinkatu 4B, FIN-00120, Helsinki, Finland
Abstract. We analyze how features of performance-related pay (PRP) schemes affect their perceived motivational effects using a Finnish survey for upper white-collar employees from 1999. The results show that the following features are important for a successful PRP scheme: (i) the employees have to feel they are able to affect the outcomes; (ii) the organizational level of the performance measurement should be close to the employee: individual and team level performance measurement increase the probability that the scheme is perceived to be motivating; (iii) employees should be familiar with the performance measures; (iv) the level of payments should be high enough and rewards frequent enough. Levels below the median do not generate positive effects; (v) employees should participate in the design of the PRP scheme. Key words: design of incentive schemes, effort provision, employee involvement, motivation, performance-related pay
1. Introduction Performance-related pay (PRP) schemes have become increasingly popular in Finland since the beginning of 1990s. For example, in 1990 around 10% of employees in Finnish industry were in a PRP scheme, whereas the figure for 1998 was close to 50%. According to the survey of the Confederation of Finnish Industry and Employers (TT, 2002), firms have adopted these schemes to motivate employees and increase wage flexibility. In that survey, 66% of the employers responded that the main reason for taking up PRP schemes for white-collar employees was the need to motivate them. The share is likely to be even higher for upper white-collar workers considered in this study. There is evidence that PRP schemes are associated with higher productivity, the most common argument for productivity increase being heightened employee motivation and effort. Both the productivity effects and the motivational aspect have been widely studied although with notable variation in the definition of PRP. Concerning productivity, it is striking that various
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forms of PRP, ranging from pure piece-rates to profit sharing schemes, have produced these positive productivity effects. Lazear (2000) finds that a shift to piece-rates led to a 44% increase in productivity. Around half of this improvement is explained by sorting effects and the other half by increased effort. On the other hand, profit sharing schemes have also been found to increase productivity.1 The productivity studies have mainly used an indicator variable for PRP in the production function. That is, they have not considered whether the features of the scheme have an impact on its effects. However, in the literature studying the motivational e
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