BLS WORKING PAPERS

U.S. DEPARTMENT OF LABOR

Bureau of Labor Statistics

 

OFFICE OF COMPENSATION AND

WORKING CONDITIONS

Compensation Supplements and Use of Incentive Pay in U.S. Job Markets

Anthony J. Barkume, U.S. Bureau of Labor Statistics

Working Paper 352

February 2002

 

The views expressed are those of the author and do not necessarily reflect the policies of the U.S. Bureau of Labor

Statistics or the views of other staff members.
Compensation Supplements and Use of Incentive Pay in US Job Markets

Anthony J. Barkume*

Compensation Research and Program Development Group

U.S. Bureau of Labor Statistics

October 2001

 

*

 I wish to thank Al Schwenk for preparing the data extract used in this paper and Will Carrington, Dave

Kaplan, and Brooks Pierce for their comments and suggestions on preliminary research. The views

expressed in this paper are those of the author and do not reflect the policies of the U.S. Bureau of Labor

Statistics. An earlier version of this paper was presented at the 1999 Southern Economics Association

meetings.
barkume_A Page 1 02/19/02

Abstract of

“Compensation Supplements and Use of Incentive Pay in US Job Markets”

Anthony J. Barkume

U.S. Bureau of Labor Statistics

The firm’s interest in monitoring and/or motivating workers appears to be an important reason

why firms use pay supplements such as bonuses and overtime work. Using a representative

sample of U.S. private industry jobs, this paper obtains some indirect evidence on what pay

supplements serve as incentive instruments. I study how various pay supplements differ in both

incidence and generosity when traditional incentive pay--pay based on individual results such as

piece rates or sales commissions--is a part of job earnings. If a firm does use incentive pay the

marginal benefit of a pay supplement as an incentive instrument should fall. Otherwise, the use

of incentive pay should have no necessary relationship to provision of a pay supplement, with

provision driven by worker preferences for the benefits provided.

The paper’s methodology follows that in Richard Freeman’s 1981 study of union-nonunion

differences in compensation supplements. (Since the data I use includes union status, I also

update Freeman’s results.) Specifically, I estimate expected employer costs per hour worked for

various compensation supplements. Across all US private industry jobs, employer costs for

bonuses not based on individual results are about half of predicted levels with use of incentive

pay. Similarly, use of incentive pay reduces expected employer spending levels in defined

contribution retirement plans by about a third. Employer spending on health insurance was

unrelated to use of incentive pay but forty percent higher in union jobs. Union jobs had more

costly compensation supplements, except for employer payments for bonuses and to defined

contribution retirement plans.

The results also suggest that use of incentive pay and collective bargaining help to accommodate

differences in worker preferences for hours of work. Among jobs with the same fulltime yearround work schedule, I estimate that a slightly higher amount of expected overtime work is

attached to a union job. But a worker choosing between full time jobs offering paid leave can

also expect about six fewer work days per year in a union job than in a job using incentive pay.

Anthony J. Barkume

Compensation Research and Program Development Group

U.S. Bureau of Labor Statistics

2 Massachusetts Ave., N.E.

Postal Square Building, room 4130

Washington, D.C. 20212

(202) 691-7527 ; e-mail: barkume_a@bls.gov
barkume_A Page 2 02/19/02

I. Introduction: Motivation and Plan of Paper

Traditional incentive pay--pay based on individual results using a predetermined

formula such as piece rates or sales commissions—embeds high-powered incentives

directly into worker compensation. Substantial earnings premiums have been found with

use of incentive pay in narrowly defined occupations even after controlling for worker

characteristics (Booth and Frank (1999)) or a switch in pay regime (Lazear (2000b)).

Most recent analysis of these earnings premiums has investigated whether workers taking

incentive pay jobs use greater work effort or have greater ability1

, since firms using

incentive pay would face higher labor costs unless workers in incentive pay jobs also had

higher productivity.

However, an earnings premium with use of incentive pay could also be consistent

with all firms offering the same total employee compensation for a particular job.

Equality of total employee compensation across firms could be possible if supplemental

employer compensation, such as cash bonuses, paid leave, overtime pay and employee

benefits, is systematically lower when the firm chooses to use incentive pay in employee

governance. The purpose of this paper is to investigate the relationship between

compensation supplements and use of incentive pay in a recent representative cross

section of the U.S. job market.

Section II develops the argument that if supplemental compensation has value to

the firm as an incentive instrument2 to monitor and motivate employees, this value falls if

the firm chooses to also use incentive pay. Although substitution between types of

incentive instruments can not be directly observed, the cross section data I use can

compare the effects of incentive pay use on different types of supplemental

compensation. For example, if health insurance does not provide the firm an incentive

 

1

 Lazear (2000a) shows how work effort and ability could interact in workers sorting into jobs using

incentive pay.

2

 Holmstrom and Milgrom (1994) emphasize that the firm has three classes of incentive instruments to

govern the employment relationship: (1) direct payments based on employee activity, (2) asset coownership (equity stakes), and (3) the job design itself, selecting production techniques and systems for

monitoring work. Our analysis is limited to the first class of incentive instruments.
barkume_A Page 3 02/19/02

instrument, use of incentive pay by the firm should not affect employer provision of

health insurance, all other things being equal.

To make these comparisons, I use a representative sample of U.S. private industry

jobs in March 1997 used in production of the Employment Cost Index (ECI) program.

Pierce (2001) uses ECI data to study the evolution of compensation inequality in the US

job market. The empirical approach follows Freeman (1980), who used establishment

data to study union-nonunion differences in supplemental compensation. Since the ECI

sample data set in this paper also includes whether collective bargaining is used in the

individual job, the study also updates Freeman’s findings on union-nonunion differences

in supplemental compensation and contrasts them with the incentive pay differences.

Section III provides the details on sample data characteristics and Section IV develops

the methodology for estimating expected differences in supplemental compensation with

use of incentive pay, controlling for detailed occupation and total compensation of the job

as well as the establishment size and industry of the employer.

Section V presents the results. As expected, bonuses not based on individual

results and use of overtime work were found to be substantially lower when incentive pay

is used on the job. For example, when incentive pay is used employer expenditures on

bonuses are predicted to be 46 percent of the level otherwise expected among all US

private industry full time jobs. I also found that expected hours of holiday/vacation leave

and employer spending on defined contribution retirement plans were both lower with

use of incentive pay, suggesting a role for worker preferences in these job market

outcomes. Not all types of supplemental compensation were found to be related to use of

incentive pay; the provision and generosity of both health insurance and defined benefit

retirement plans are not significantly different across all US private industry jobs when

incentive pay is used. Consistent with Freeman’s earlier results, we find that union jobs

have substantially higher expected spending on all supplemental compensation except on

cash bonuses and on defined contribution retirement plans.

We conclude the paper with some speculations about how the interaction of

employer motives and worker preferences can explain the findings of substantial
barkume_A Page 4 02/19/02

differences in hours of work between incentive pay and union jobs. Incentive pay jobs

may attract workers with preferences for higher work hours (lower demands for leisure)

since accrual of paid leave in the work schedule provides a means to generate higher

hours of work. If a hypothetical worker in US private industry chose a job using

incentive pay instead of a union job, then the results predict that the worker could obtain

an additional fulltime week of work per year, even when both jobs offer the same year

round forty hour week work schedule. However, attached to the offer of a union job is a

higher amount of overtime work than in nonunion jobs.

II. Supplemental Compensation and Use of Incentive Pay

Some types of supplemental compensation can help the firm to motivate and/or

monitor workers. Besides the obvious incentive role of overtime premiums, paid

vacation or sick leave may provide an instrument to monitor absenteeism and coordinate

work schedules3

, and group bonuses (including, but not limited to, profit-sharing) can

encourage teamwork in the workplace. Also, pensions can provide an implicit

performance bond to workers to promote the formation of firm-specific capital (see

Ippolito (1997)).

If a particular type of supplemental compensation can help the firm to govern the

employment relationship, it should have less value to the firm when using incentive pay.

Starting with Williamson (1975), when the nature of the job or the work setting makes it

feasible, payment based on individual results has been characterized as a “high powered”

incentive.4

 With incentive pay, tenure or reliability considerations are less important to

the employer. Deferred compensation is less important to workers or the firm because

there is no need to bargain over the returns to job-specific human capital; workers are

paid on their results regardless of whether these results could be replicated in other firms.

Monitoring is less important because, as Pencavel (1977) notes, incentive pay provides

employers an automatic “on-the-job screening” capability because earnings are adjusted

 

3

 See, for example, Reisenweitz (1997).

4

 Of course, as Lazear (2000) stresses, many other compensation schemes can be high-powered in the

appropriate work setting. Lazear stresses the value of incentive pay to sort those in a heterogeneous work

force with the greatest productivity to their most efficient employment.
barkume_A Page 5 02/19/02

for variations in productivity and effort between employees. Thus, use of incentive pay

in job compensation should be associated with lower incidence and/or generosity for paid

leave, retirement benefits, or other compensation supplements that the firm would have

otherwise used in employee governance.

If use of incentive pay lowers the share of supplemental compensation in total

employee compensation, earnings premiums with incentive pay overstate corresponding

premiums in total employee compensation. Using various samples from the BLS Industry

Wage Surveys of earnings in narrowly defined occupations within the same industry, a

variety of different studies have found an earnings premium for piece rate pay of eight to

ten percent5

. Later analysis of household data sets having broader job coverage--but also

having less precise information on method of pay--are also consistent with the earlier

results using direct job comparisons; see Booth and Frank (1999) and Parent (1999).

However, a significant limitation to this earnings premium research has been lack of data

on total employee compensation. Instead, individual cash earnings in piece rate jobs

have been compared to the straight time (that is, exclusive of bonuses, overtime, or shift

differentials) wage rate in jobs not using piece rates.

The aggregate data from the ECI program indicate that an earnings premium for

piece rate pay could even be consistent with the absence of an incentive pay differential

in total employee compensation. Published data, shown in Table 1, show that employer

costs for supplemental compensation (termed “Benefit Costs” in the ECI program) are a

large share of total employee compensation among blue-collar worker occupations where

piece rate pay is more prevalent. Excluding costs for “Legally Required Benefits”

(employer payroll taxes, workers’ compensation insurance), costs for supplemental

compensation were $3.26 per hour worked among Machine Operators, Assemblers, and

Inspectors in March 2001. If a ten percent premium for straight-time pay in incentive pay

jobs in this occupational group was offset by $1.34 less in supplemental compensation,

there would be no differential in total employee compensation with incentive pay.

 

5

 See Brown (1992), King (1975), Mitchell, Lewin, and Lawler (1990), Petersen (1992), and Seiler (1984).
barkume_A Page 6 02/19/02

In contrast, Freeman (1981) found that because supplemental compensation is a

greater share of total compensation in union jobs, the union premium in straight time pay

understated the total compensation per hour differential. Using data for larger firms,

Freeman estimated, for U.S. private industry as a whole, a straight-time pay per hour

union premium of 15.9 percent but a total compensation per hour differential of 18.8

percent, reflecting the larger share of pay supplements in union compensation.6

 Freeman

hypothesized that this difference reflected the greater importance of average worker

preferences in the collective bargaining process, assuming that the average worker would

have a higher demand for benefits than would marginal workers.

III. Data Characteristics

To examine the empirical association between incentive pay and supplemental

compensation, I used a March 1997 cross-section of ECI micro data (with the job as the

unit of observation). To produce the ECI, detailed information is collected at the

employer’s establishment on individual earnings as well as on employer expenditures for

various elements of supplemental compensation, including employee benefits.

Expenditures on supplemental compensation are intended as a measure of the expected

payments attached to sample jobs, reflecting the usual amounts that would be accrued per

hour worked over the work year (e.g., usual overtime hours worked per year, usual hours

of paid sick leave taken over the year). Data on characteristics such as the detailed

occupation of the job, the industry of the employing establishment, the establishment

size, and whether the job is full time or covered by a collective bargaining agreement, are

also obtained for each sampled job. Pierce (2001) uses ECI micro data to study the

evolution of inequality of total employee compensation in the U.S. job market.

Although not now used in published ECI series, ECI data collection includes an

indicator whether incentive pay is used in sample jobs.7

 The incentive pay indicator

captures jobs where straight-time wages or salaries “...are tied, at least in part, to

 

6

 See Freeman (1981, p.504); I am reporting the antilogs of the log differentials that Freeman presented.

7

 For more information on the incentive pay classification and evidence that the presence of incentive pay

provisions increases the time series volatility of the ECI, see Barkume and Moehrele (2001).
barkume_A Page 7 02/19/02

commissions, production bonuses, piece rates, or other individual incentives”8 and

excludes profit-sharing distributions, all-employee payments, or other “nonproduction

bonuses” because the latter payments are not directly linked to the individual worker’s

efforts. However, jobs in which tip income is customary are not classified as including

incentive pay because the employer incurs no direct cost. Since tip income also provides

high-powered incentives but cannot be identified in the ECI data, I excluded sample

observations in selected service occupations9

 in which I expected tip income to be

prevalent.

The ECI sample data do have some limitations linking compensation with use of

incentive pay. Individual worker characteristics are not obtained in ECI data collection

and all data records are job averages (e.g., average pay across all job incumbents). Also

not retained in the permanent data files is the proportion of straight-time pay derived

from the incentive pay formula, or whether the incentive pay formula is based on sales

(e.g., commissions) or production (e.g., piece rates). However, incentive pay formulas

usually reflect commissions among sales and managerial10 occupations and piece rates or

other production bonuses among skilled production workers. Thus, additional separate

comparisons were made among these two occupational groups.

Summary descriptions of the data for the March 1997 cross section are shown in

Table 2. Sample sizes are the numbers of jobs sampled while the means and standard

deviations reflect the employment weights of sample jobs. (The use of sample design

information in estimation is discussed below.) Because past research indicates that parttime employment reduces both compensation levels and supplemental compensation11,

the samples were restricted to jobs with full time work schedules. Note that managerial

and sales occupations and skilled production worker12 occupations have a higher

 

8

 ECI Collection Manual, p.68

9

 These occupations comprised an estimated 4.1 percent of US private industry employment in March 1997

and included jobs in the following occupation titles: Taxicab Drivers and Chauffeurs, Bartenders,

Waiters/Waitresses, Barbers, Hairdressers and Cosmetologists, and Baggage Porters and Bellhops.

10 Two occupations in the Managers group that have a high incidence of incentive pay are Sales Managers

and Financial Underwriters.

11 See, for example, Lettau (1997).

12 I include as “skilled production” jobs all occupation titles that are in the following Census occupation

groups: Precision Production, Craft and Repair; Machine Operators, Assemblers, and Inspectors;

Transportation and Material Moving Occupations.
barkume_A Page 8 02/19/02

incidence of use of incentive pay than among all private industry jobs. Earnings and

employers costs are expressed as dollars per hour worked.13 The total employer

voluntary costs measure in the second row of Table 2 is total employer costs net of

payroll taxes and other mandated benefits.

Table 2 also presents data on both the incidence and generosity of supplemental

compensation among jobs in the sample. Panel I of Table 2 provides summary incidence

information on the types of supplemental compensation to be analyzed, the use of

incentive pay, and collective bargaining coverage. Because less than 0.5 percent of

employment are in jobs that have both collective bargaining and use incentive pay, the

interaction between these two job characteristics was not studied. Panels II and III of

Table 2 provide measures of how generous is the supplemental compensation in jobs

where it is provided. Since employer costs for paid leave and overtime reflect the straight

time pay rate as well as hours, I converted employer costs for both paid leave and

overtime into “accrual rates”—hours accrued per thousand hours worked—by dividing

these costs by the straight time pay rate.14. For ease of interpretation Panel III of Table 2

presents these rates as hours obtained per thousand hours of work. Using US private

industry sample averages, these accrual rates imply about 155 hours of holiday and

vacation leave are earned annually jobs in providing this kind of leave and about 44 hours

of overtime are worked in jobs providing overtime premiums.

IV. Estimation Methodology

Expected differences in employer costs for employee compensation with use of

incentive pay, controlling for other job characteristics, depend on the combined effects of

the use of incentive pay on incidence and generosity. Let PS denote the probability of a

job offering supplemental compensation type S and ES as employer expenditures per hour

worked when S is offered so that expected expenditures in a sample of jobs is PS ES.

Consider then the partial differentiation of PS ES with respect to use of incentive pay.

 

13 Hours worked is defined as the year round work schedule plus annual overtime hours less annual hours

of paid leave.

14 To obtain the overtime hours accrual rate, I divided by one and a half times the pay rate to reflect the

overtime premium.
barkume_A Page 9 02/19/02

Using the log of PS ES to emphasize relative differences and I to denote use of incentive

pay, then

(I) ∂ log(PS ES) / ∂I = ∂ log(PS) / ∂I + ∂ log(ES) / ∂I.

Thus, implicit partial (job characteristics held constant) indexes of expected relative costs

of employer costs for supplemental compensation can be derived by combining estimates

of incidence effects and generosity effects from use of incentive pay.

The estimation strategy follows the approach used by Freeman (1981) to analyze

union-nonunion differences in supplemental compensation. Reduced-form regressions

on measures of the incidence and generosity of supplemental compensation include a

dummy variable indicator for whether incentive pay is used on the job along with other

job characteristics. The regression coefficient on the incentive pay indicator indicates the

predicted difference in supplemental compensation in the job market with use of

incentive pay, holding total job compensation and other job characteristics (e.g.,

occupation, industry, establishment size, collective bargaining status) constant. When

these predicted differences were not statistically significant, I inferred that use of the

supplemental compensation did not systematically vary with use of incentive pay.

The use of incentive pay as a predetermined variable in the supplemental

compensation equations can be justified in the following way. Rather than viewing the

firm’s use of incentive pay, the market rate of compensation for a job, and the

compensation mix for a job as mutually determined it is reasonable to consider the

determination of this set of variables as a recursive process. Firms choose the method of

pay based on occupational characteristics, the production processes of the industry, the

type of capital investment, as well as possibly many factors that are idiosyncratic to each

establishment.15 Given the firm choice of use of incentive pay, the job market matches

up workers with jobs, determining compensation levels and thus also the differentials in

compensation with observable job characteristics. Given use of incentive pay and total

market compensation, preferences of workers for supplemental compensation and the

 

15 For further discussion, see MacLeod and Parent (1998).
barkume_A Page 10 02/19/02

costs and benefits to firms of providing supplemental compensation determine the mix of

compensation.

From this job market perspective, the estimates of (I) depend on both firm

interests and worker preferences in the allocation of compensation between wage

earnings and pay supplements. Thus, obtaining negative values for estimates of (I) does

not necessarily imply that the use of incentive pay reduces the marginal benefit of the pay

supplement to the firm, because the result may also reflect different preferences among

workers in jobs using incentive pay. However, if incentive pay does reduce the marginal

benefit of the pay supplement as an incentive instrument, we should never observe a

positive estimate for (I). Furthermore, if a particular compensation supplement is not an

incentive instrument for the firm (as would be expected for provision of health insurance,

for example) there should be no differences with incentive pay unless the workers in

incentive pay jobs value that particular compensation supplement differently than other

workers.

If use of incentive pay were only specific to some occupations, it would be

impossible to distinguish whether differences in supplemental compensation were due to

method of pay rather than occupational differences. All regression equations do include

indicators for the detailed occupational title (i.e., a 4-digit Census occupational code) of

the sample job so that the predicted effects reflect differences with use of incentive pay

within a detailed occupation.16 This margin is empirically important because the ECI

data show that detailed occupation does not determine use of incentive pay. In the ECI

sample, incentive pay used for all sample jobs in only two occupations (Fishers, Hunters,

and Trappers, and Hand Molding Occupations) that represent a negligible share of U.S.

private industry employment. In fact, a considerable number of within-occupation

comparisons can be made because the ECI sample also indicates that more than twothirds (68.2 percent) of U.S. private industry employment is in detailed occupations that

use incentive pay in some, but not all, jobs in the occupation.

 

16 In making comparisons across all US private industry jobs, there are controls for 447 occupational titles.
barkume_A Page 11 02/19/02

ECI data collection also provides a number of other relevant statistical controls.

All equations include dummy variable indicators for establishment employment size

ranking and the industry of the establishment, and whether compensation of the sample

job was determined through collective bargaining (union jobs). The industry

classification has seventy-two indicators (essentially, a BLS variation on the 2-digit SIC

classification of the employing establishment). To allow the effect of establishment size

to be nonlinear, the establishment size indicator used in the regressions was the decile

ranking of the establishment in the distribution of employment in U.S. private industry.

To allow for possible nonlinear effects of total job compensation on worker demand for

supplemental compensation, the total compensation indicator used was the decile ranking

of the total compensation of the job in the distribution of total compensation across all

full-time jobs in U.S. private industry.

All regression equations were least squares estimates, with adjustment of standard

errors to reflect the ECI sample design. The ECI has a two stage sampling process; the

establishment is the primary sampling unit with subsequent random draws of one to

seven jobs from a list of all jobs employed within the establishment. Thus, regression

errors across jobs within the same establishment will be correlated when firms provide

the same pay supplements for all jobs in the establishment. Standard errors were

estimated using Huber-White procedures, using the ECI sampling weight information and

allowing for interdependence of errors between jobs sampled from the same

establishment.

V. Estimated Effects of Incentive Pay and Collective Bargaining on Pay

Supplements

Using a March 1997 ECI micro data cross section, estimates of (I) were obtained

for expected accrual rates for hours of overtime work and holiday/vacation leave and for

expected employer spending per hour worked on bonuses, health insurance, defined

benefit retirement benefits, and defined contribution retirement benefits. Holding other

job characteristics constant, use of incentive pay was estimated to lower both hours of

overtime and hours of holiday vacation leave and also to lower employer spending on
barkume_A Page 12 02/19/02

bonuses and on defined contribution retirement plans. (Estimated effects on expected

employer spending on health insurance and defined benefit retirement depended on the

types of occupational comparisons used; these patterns are discussed in further detail

below.) Thus, use of incentive pay systematically lowers the share of total compensation

derived from supplemental compensation, holding other job characteristics constant. In

contrast, the presence of collective bargaining systematically raises the share of total job

compensation derived from individual straight-time cash earnings because union jobs are

predicted to have higher spending on all the pay supplements examined except bonuses,

holding other job characteristics constant.

V.1 Incidence of Pay Supplements

Linear probability equations were used to obtain estimates of the incidence

effects. Maximum likelihood (ML) techniques (e.g., a probit specification) cannot be

used with large numbers of dummy variables (see Greene (1997)); in our statistical

design, over five hundred dummy variables are used as statistical controls in the US

private industry comparisons. (The large number of dummy variables largely reflects the

controls for detailed occupation of the job, in order to make within-occupation

comparisons.) Also, unambiguous comparisons of goodness of fit across equations for

the different types of pay supplements studied can not be obtained with use of ML

techniques (see Gronau (1998)).

Table 3 presents the results on incidence. Panel I (first three columns) provide

results estimating linear probability models using all US private industry data; Panels II

and III restrict the comparisons to the managerial and sales jobs data and the skilled

production jobs data, respectively. The first column in each panel reports the adjusted Rsquare of the estimating equation and the next two columns report the estimated

probability differences with use of incentive pay and collective bargaining (union job),

respectively. (The effects of interactions between use of incentive pay and collective

bargaining were not estimated because only 0.5 percent of all US private industry

employment are in jobs with both incentive pay and collective bargaining.)
barkume_A Page 13 02/19/02

For U.S. private industry as a whole, use of incentive pay is predicted to reduce

the probability of the job offering overtime work, bonuses, and paid vacation leave, with

the largest estimate effect on the offer of overtime work. The predicted probability of the

job offering a defined contribution retirement plan was higher among managerial and

sales jobs but lower among skilled production jobs with use of incentive pay. Use of

incentive pay had no statistically significant effects on the incidence of either defined

benefit retirement plans or health insurance.

The estimated effects of a collective bargaining agreement--having a union job—

on the incidence of pay supplements are quite different than the incentive pay effects.

Having a union job has no significant effect on the offering of holiday/vacation leave or

bonuses but increases the probability of the job offering overtime work, health insurance,

or a defined benefit retirement plan, with the largest impact on the offering of overtime

work. The predicted increase in offering a defined benefit retirement plan in union jobs

reflects for the most part a substitution away from the offer of a defined contribution

retirement plan. For example, in the US private industry comparisons, union jobs are

predicted to have a 0.326 increase in the probability of offering a defined benefit

retirement plan but also a 0.289 decrease in the probability of offering a defined

contribution retirement plan.

V.2 Generosity of Pay Supplements

Table 4 presents the results for the other component of expected employer costs

for supplemental compensation, how generous is the compensation where provided. The

setup of Table 4 is similar to that for the incidence results in Table 3, although sample

sizes vary between types of supplemental compensation because the analysis excludes

jobs not offering the supplemental compensation. The generosity of overtime payments

and paid holiday-vacation leave are expressed as “accrual rates”--hours per hour worked.

Accrual rates are used for overtime and paid leave because costs are a direct function of

straight-time earnings (one and a half times earnings for overtime pay). The equations

for expenditures on supplemental compensation are in semi-log forms, so that the
barkume_A Page 14 02/19/02

coefficients on the indicators for the job characteristics estimate relative differences in

expenditures per hour worked.

The results in Table 4 show that when a job offers paid holiday or vacation leave,

workers in jobs using incentive pay accrue fewer hours. In both the skilled production

and managerial/ sales occupation groups, workers are predicted to also have less overtime

work where overtime is used, although no systematic differences in overtime use were

found when the comparisons were extended to all US private industry jobs. Among all

US private industry jobs, spending on bonuses and defined contribution retirement is

predicted to be lower with use of incentive pay, but with no systematic differences in

employer spending for health insurance benefits or defined benefit retirement plans.

(However, comparing among managerial and sales occupations, use of incentive pay is

associated with lower employer spending on all four types of compensation

supplements.)

As with the incidence effects the incentive pay differences contrast sharply with

the union-nonunion differences. Workers in union jobs that offer overtime and paid leave

are predicted to work more hours of overtime but also receive hours of more paid time

off. The use of collective bargaining in a job is associated with no systematic differences

in spending on bonuses where they are provided, but increases in employer spending on

health insurance benefits. As in the case of incidence, employer spending on retirement

benefits in union jobs appears to reflect in part a substitution of contributions to defined

benefit retirement plans for contributions to defined contribution plans, relative to

spending in nonunion jobs.

V.3 Indexes of Expected Costs for Pay Supplements

Table 5 presents antilogs of estimates of (I)--the derivatives of expected log costs,

or expected hours accrued, with use of incentive pay or collective bargaining. These data

reflect both incidence and generosity effects but are partial indexes because they set

expected costs or hours accrued in nonunion jobs not using incentive pay to 100 hold

other job characteristics constant. (Entries of 100 indicate that these job characteristics

had neither a statistically significant effect on incidence or on generosity of that type of
barkume_A Page 15 02/19/02

supplemental compensation.) In the comparisons across all US private industry jobs,

employer costs for bonuses are about half (46.1 percent) of what they otherwise would be

with use of incentive pay and about two thirds (66.94 percent) of an expected employer

spending levels for defined contribution retirement. Following the consistent patterns of

effects of collective bargaining on both the incidence and generosity of pay supplements,

the use of collective bargaining increases the expected costs of all pay supplements

except bonuses (unaffected) and defined contribution retirement plans (reduced).

Reductions in spending for defined contribution retirement in union jobs reflects a

substitution toward providing retirements in union jobs in traditional defined retirement

benefits, which has employer spending from two to three times the level expected with

nonunion jobs having similar job characteristics, depending the type of job comparison

made.

VI. Conclusions: Job Characteristics and Worker Choice of Pay

Supplements

To analyze how pay supplements vary in the U.S. job market this paper

emphasizes the importance of the interest of the firm in employee governance. I obtained

some indirect evidence on this issue by observing differences in the firm’s offer of

various pay supplements when the firm can use the high-powered incentives embedded in

incentive pay schemes such as piece rates or commissions. As expected, use of cash

bonuses not based on individual results and amount of overtime hours worked are both

predicted to be lower with use of incentive pay (holding a range of other job

characteristics constant). However, because use of incentive pay is also associated with

differences in offers of paid leave and retirement contributions, it seems reasonable that

worker preferences also play a role in these job market differences as well.

The results have some further implications about how usual hours of work vary

with use of incentive pay or collective bargaining. While worker preferences between

income and leisure may drive long run changes in hours at work, we rarely observe

workers negotiating different hours of work within the same establishment. Uniform
barkume_A Page 16 02/19/02

hours of work in the establishment helps the firm to achieve predictable work schedules

and to exploit the advantages of team production.

But workers do still have a choice of work schedules through selecting different

jobs. Even with wide-spread use of a standard 40 hour work week, workers can vary

desired hours of work by searching for jobs with different provision of paid leave and/or

utilization of overtime work; more overtime hours increase the effective work week while

more paid leave reduces it. The results of this paper imply that worker choice of job with

incentive pay or with a union contract can substantially change effective hours of work

given the same full-time schedule. Workers with a low preference for leisure relative to

income should be attracted to incentive pay jobs while workers with a high preference for

leisure relative to income should be attracted to union jobs (although the results also

show that more overtime hours of work are associated with union jobs).

To see how the empirical results characterize the range of choice in effective

hours of work, consider worker choice between union jobs, nonunion jobs using incentive

pay, and nonunion jobs without incentive pay assuming each job alternative offers both

paid holiday/vacation leave and usual overtime work. What then are predicted

differences in hours of work among these job alternatives from the results of this paper,

holding constant other job characteristics17 used in the statistical controls?

Table 6 provides the relevant predictions using a uniform year round 40 hours a

week work schedule (2080 hours per year) and the job market sample means given for

accrual rates for overtime work and paid leave given in Table 2. On average, the

provision of holiday/vacation leave reduces annual hours of work in nonunion jobs not

using incentive pay by about 19 days per year (155 hours per year). In contrast, the use

of overtime work in these jobs increases the work year by about 44 hours per year among

full time U.S. private industry jobs (but 62 hours per year in skilled production jobs).

Applying the Table 4 regression estimates to these baseline estimates implies that

nonunion jobs using incentive pay should have about 3 1⁄2 less days per year (28.25 hours

 

17 These job characteristics were: detailed occupation of the job, industry of the establishment, decile

ranking of the job in the distribution of total job compensation in U.S. private industry, and decile ranking

of establishment in the distribution of establishment employment size in U.S. private industry.
barkume_A Page 17 02/19/02

per year) paid leave while union jobs should have about about 2 1⁄2 more days per year

(22.18 hours per year). Thus, the results suggest that a worker choosing a job with

incentive pay instead of a union job is predicted to have an effective decrease of over 50

hours of paid leave per year (among all US private industry full time jobs). Union jobs

also are predicted to require more overtime work, but the increase in hours worked

choosing a job with incentive pay over a union job is still more than a week a year (about

43 hours) more after netting out the additional overtime work predicted by the results for

union employment. Further investigation of how these differences in hours of work

influence earnings premiums in both union jobs and with use of incentive pay would be

useful.
barkume_A Page 18 02/19/02

References

Barkume, Anthony J. and Thomas Moehrle, “The Impact of Incentive Pay on the

Volatility of the Employment Cost Index,” Compensation and Working Conditions

(forthcoming 2001).

Booth, Allison L. and Jeff Frank, “Earnings, Productivity, and PerformanceRelated Pay,” Journal of Labor Economics, vol. 17, no.3 (July 1999), pp. 447-463.

Brown, Charles, “Wage Levels and Methods of Pay,” Rand Journal of

Economics, vol. 23, no.3 (Autumn 1992) pp. 366-375.

Freeman, Richard B., “The Effect of Unionism on Fringe Benefits,” Industrial

Labor Relations Review, vol.34 (July 1981), pp.489-509.

Greene, William H., Econometric Analysis, (Third Edition) Prentice-Hall, New

Jersey 1997.

Gronau, Reuben, “A Useful Interpretation of R2 in Binary Choice Models (Or,

Have we Dismissed the Good Old R2

 Prematurely?) Working Paper #397, Industrial

Relations Section, Princeton University, February 1998.

Gruber, Jonathan, and Michael K. Lettau “How Elastic is the Firm’s Demand for

Insurance?” NBER Working Paper 8021, November 2000.

Holmstrom, Bengt and Milgrom, Paul, “The Firm as an Incentive System,”

American Economic Review, vol. 84 (September 1994) no. 4, pp. 972-991.

Ippolito, Richard A., Pension Plans and Employee Performance: Evidence,

Analysis, and Policy. University of Chicago, 1997.

King, Sandra L, “Incentive and Time Pay in Auto Dealer Repair Shops,” Monthly

Labor Review, vol.98 (September 1975), pp.45-48

Lazear, Edward P., “The Power of Incentives,” American Economic Review,

vol.90, no.2 (May 2000), pp.410-414.

Lettau, Michael K., “Compensation in Part-time Jobs vs. Full-time Jobs: What if

the Job is the Same?” Economic Letters, vol. 56 (1997), pp. 101-106.

MacLeod, W. Bentley and Daniel Parent, “Job Characteristics and the Form of

Compensation,” Research in Labor Economics, vol.18 (1999), pp. 177-242.

Mitchell, Daniel J. B., David Lewin, and Edward E. Lawler III, “Alternative Pay

Systems, Firm Performance, and Productivity,” in Paying for Productivity, Alan S.

Blinder, editor, Brookings Institution, Washington , D.C. 1990, pp. 15-94.
barkume_A Page 19 02/19/02

Parent, Daniel. “Method of Pay and Earnings: A Longitudinal Analysis”

Industrial and Labor Relations Review,” vol. 53, no.1 (October 1999), pp.71-86.

Pencavel, John H. “Work Effort, On-The-Job Screening, And Alternative

Methods of Renumeration,” Research in Labor Economics: An Annual Compilation of

Research, Ronald G. Ehrenberg, editor (vol. 1, 1977) JAI Press, pp. 225-258.

Petersen, Trond. “Reward Systems and the Distribution of Wages,” Journal of

Law, Economics, and Organization, vol. 7, Special Issue, 1991, pp. 130-158

Pierce, Brooks, “Compensation Inequality,” Quarterly Journal of Economics

(forthcoming, 2001).

Reisenwitz, Eric M., “Absence/Lost Time Management: Strategies to Keep the

Workforce Productive,” Benefits Quarterly, vol. 13 (1997), no. 4, pp.19-25

Seiler, Eric, “Piece Rate vs. Time Rate: The Effect of Incentives on Earnings”

Review of Economics and Statistics, vol. 66 (August 1984), pp. 363-364.

Williamson, Oliver, Markets and Hierarchies: Analysis and Antitrust Implications

New York: Free Press, 1985.
barkume_A Page 20 02/19/02

Table 1. Employer costs per hour worked for employee compensation, U.S. private

industry full time jobs, March 2001

All workers in

private industry

Machine Operators,

Assemblers, and

Inspectors

Total Compensation $20.81 $19.35

Wages and Salaries

(includes incentive pay)

$15.18 $13.48

Benefit Costs, Total $5.63 $5.87

 Paid Leave

(e.g., vacation and sick leave)

$1.37 $1.08

 Supplemental Pay

(e.g., overtime pay and bonuses)

$0.61 $1.00

 Insurance

(e.g., health insurance premiums)

$1.28 $1.57

 Retirement and Savings

(e.g., contributions to 401k plans)

$0.62 $0.51

 Legally Required Benefits

(e.g., payroll taxes)

$1.73 $1.61

 Other Benefits $0.02 $0.05

Source: Extract from Table 10 of Bureau of Labor Statistics news release “Employer

Costs for Employee Compensation – March 2001” issued June 29, 2001.
barkume_A Page 21 02/19/02

Table 2. Summary Statistics (ECI samples of full time jobs in US private industry employment,

March 1997)

All private industry

(N=15,257)

Managerial and Sales

Occupations (N=4,172)

Production Worker

Occupations (N=3,494)

Straight-time earnings

(dollars per hour

worked)

14.721

(10.569)

17.075

(14.711)

12.958

(5.524)

Total employer

voluntary costs (dollars

per hour worked)

18.938

(14.994)

21.165

(19.391)

17.003

(8.387)

I. Employment incidence in jobs :

-with incentive pay

provisions

.0784 0.174 0.094

-with collective

bargaining agreement

0.139 0.037 0.269

-providing paid holiday

or vacation leave

0.929 0.841 0.902

-using overtime

premium payments

0.606 0.356 0.806

-paying nonproduction

bonuses

0.421 0.405 0.444

-paying for health

insurance

0.849 0.714 0.845

-with defined benefit

pension plan

0.333 0.253 0.399

-with defined

contribution retirement

0.553 0.516 0.515

II. Employer costs (dollars per hour worked) in jobs providing:

-nonproduction bonuses 0.995

(7.301)

1.431

(4.784)

0.415

(0.674)

-health insurance 1.432

(0.979)

1.430

(0.930)

1.594

(1.121)

-defined benefit

retirement

1.069

(5.156)

1.769

(12.446)

1.117

(1.210)

-defined contribution

retirement

0.648

(0.918)

0.953

(1.265)

0.491

(0.660)

III. Accrual rates (hours per thousand hours worked) in jobs providing:

Paid holiday or vacation

leave

78.76

(38.77)

79.34

(39.45)

77.75

(41.77)

Work hours with

overtime premium

22.28

(23.28)

15.62

(19.59)

31.36

(25.39)

Source: Job level data from the Employment Cost Index sample for March 1997; means

and standard deviations (in parentheses)

barkume_A Page 23 02/19/02

Table 3. Incidence effects: predicted differences in offering pay supplements with use of incentive pay or collective bargainin

g

agreements on pay supplement in full time jobs, March 1997

I. All US private industry

(N = 15,257)

II. Managerial and sales occupations

(N = 4,172)

III. Skilled production occupations

(N=3,494)

AdjustedR-square

Use of

Incentive

Pay

Collective

BargainingAgreement

AdjustedR-square

Use of

Incentive

Pay

Collective

BargainingAgreement

AdjustedR-square

Use of

Incentive

Pay

Collective

BargainingAgreement

OvertimeWork

0.393 -0.1964*

(0.0283))

0.1136*

(0.0209)

0.382 -0.0280

(0.0496)

0.2369*

(0.0561)

0.315 -0.2576*

(0.0461)

0.0571*

(0.0276)

Holiday orVacationLeave

0.310 -0.0769*

(0.0168)

-0.0137

(0.0112)

0.506 -0.0588

(0.0384)

-0.0536

(0.0369)

0.361 -0.0633*

(0.0300)

-0.0292

(0.0171)

Bonuses 0.125 -0.1420*

(0.0292)

-0.0526

(0.0308)

0.158 0.1324

(0.0709)

-0.0938

(0.0620)

0.153 -0.1019

(0.0524)

-0.0504

(0.0480)

HealthInsurance

0.394 -0.0070

(0.0201)

0.0417*

(0.0116)

0.428 0.0256

(0.0312)

-0.0411

(0.0299)

0.453 0.031

(0.0330)

0.0412*

(0.0160)

DefinedBenefitRetirement

0.388 -0.0367

(0.0367)

0.3268*

(0.0285)

0.316 0.0008

(0.0606)

0.1405*

(0.0591)

0.498 0.0474

(0.0417)

0.3209*

(0.0435)

DefinedContrib.Retirement

0.289 -0.0452

(0.0308)

-0.2897*

(0.0312)

0.275 0.1155*

(0.0478)

-0.2065*

(0.0643)

0.339 -0.1342*

(0.0515)

-0.3050*

(0.0491)

Source: Job level data from the Employment Cost Index sample for March 1997. Probabilities obtained from estimation of linearprobability model. Statistical controls include: four-digit Census occupational title, two-digit SIC industry of establishment, decileranking of the job in the US private industry distribution of total job compensation net of legally required costs, and the decile ranking

of the employing establishment in the establishment employment size distribution in U.S. private industry
barkume_A Page 24 02/19/02

Table 4. Generosity effects: predicted differences in hours accrued or employer costs in jobs using compensation supplements, fulltime jobs, March 1997

I. All US private industry II. Managerial and sales occupations III. Skilled production occupations

Adjusted Rsquare and

N

Use of

Incentive

Pay

Collective

Bargaining

Agreement

Adjusted Rsquare and

N

Use of

Incentive

Pay

Collective

Bargaining

Agreement

Adjusted Rsquare and

N

Use of

Incentive

Pay

Collective

Bargaining

Agreement

Hours accrued:

-OvertimeWork

0.304

(N=9,127)

-0.00448

(0.00265)

0.00356*

(0.00135)

0.218

(N=2,476)

-0.00532*

(0.00135)

0.00883*

(0.00242)

0.249

(N=3,142)

-0.01056*

(0.00308)

0.00442*

(0.00191)

-HolidayVacationLeave

0.515

(N=14,415)

-0.01435*

(0.00161)

0.01127*

(0.00184)

0.619

(N=4,144)

-0.01810*

(0.00230)

0.01244*

(0.00393)

0.596

(N=3,350)

-0.01457*

(0.00304)

0.01018*

(0.00312)

Log employer costs:-Bonuses 0.479

(N=6,823)

-0.4236*

(0.1383)

-0.2368

(0.1210)

0.590

(N=1,902)

-0.4340*

(0.1438)

-0.2738

(0.3599)

0.422

(N=1,619)

-0.2879

(0.1942)

-0.0760

(0.1584)

-HealthInsurance

0.243

(N=13,871)

-0.0960

(0.0897)

0.3010*

(0.0556)

0.251

(N=3,463)

-0.2958*

(0.1312)

0.4123*

(0.1845)

0.337

(N=3,093)

0.0590

(0.1421)

0.1778*

(0.0802)

-DefinedBenefitRetirement

0.478

(N=6,597)

-0.1240

(0.1027)

0.3605*

(0.0924)

0.630

(N=1,554)

-0.2826*

(0.1346)

0.3500*

(0.1774)

0.571

(N=1,710)

0.0058

(0.1648)

.1772

(0.1453)

-DefinedContrib.Retirement

0.520

(N=9,678)

-0.4013*

(0.0789)

-0.1768*

(0.0797)

0.590

(N=2,642)

-0.5260*

(0.0852)

0.0853

(0.1823)

0.503

(N=1,997)

-0.2699

(0.1857)

-0.2362*

(0.1163)

Source: Job level data from the Employment Cost Index sample for March 1997. Least squares estimates with additional statisticalcontrols for: four-digit Census occupational title, two-digit SIC industry of establishment, decile ranking of the job in the US private

industry distribution of total job compensation net of legally required costs, and the decile ranking of the employing establishment in

the establishment employment size distribution in U.S. private industry
“Compensation Supplements and Use of Incentive Pay in US Job Markets”

barkume_A Page 25 02/19/02

Table 5. Partial Indexes of expected relative costs of pay supplements with use of

incentive pay or collective bargaining

(Nonunion jobs without incentive pay and same job characteristics =100)

All private industry Managerial/Sales Skilled Production

Use of

Incentive

Pay

Collective

Bargaining

Agreement

Use of

Incentive

Pay

Collective

Bargaining

Agreement

Use of

Incentive

Pay

Collective

Bargaining

Agreement

I. Expected accrual rates

-Overtime

Work

72.73 141.00 71.13 342.37 51.87 123.58

-HolidayVacation

Leave

76.72 115.38 79.60 116.97 77.24 114.03

II. Expected log employer costs:

-Bonuses 46.10 100.0 64.79 100.0 100.0 100.0

-Health

Insurance

100.0 141.92 74.39 151.02 100.0 125.4

-Defined

Benefit

Retirement

100.0 382.62 75.38 247.27 100.0 223.50

-Defined

Contrib.

Retirement

66.94 49.62 73.92 67.01 77.06 43.67

Source: Antilog of estimate of Equation (I) in the text combining incidence and

generosity effects reported in Tables 3 and 4.

An index value of 100 indicates that neither the incidence nor generosity effect of the job

characteristic was statistically significant.
“Compensation Supplements and Use of Incentive Pay in US Job Markets”

barkume_A Page 26 02/19/02

Table 6. Predicted differences in annual mean hours of paid leave and overtime with use

of incentive pay and collective bargaining in US full time jobs providing these pay

supplements (generosity effects), March 1997

All Private

Industry

Managerial

and Sales

Skilled

Production

mean hours of work1 1968 1955 1987

mean overtime hours2 43.8 30.5 62.3

mean holiday/vacation

leave hours2

155.1 155.1 154.5

I. Predicted differences in annual hours of paid holiday or vacation leave3

:

-with use of incentive pay -28.25 -35.39 -28.96

-with collective bargaining 22.18 24.32 20.23

II. Predicted differences in annual hours of overtime work3

:

-with use of incentive pay 04 -10.40 -20.99

-with collective bargaining 7.01 17.26 8.78

Notes:

1. Mean hours of work equals 2080 hours (full time year round work schedule) plus

mean overtime hours minus mean hours of holiday or vacation paid leave in Table 2.

2. Applying mean hours of work to accrual rates in Table 2

3. Mean hours of work applied to regression coefficients in Table 4.

4. A zero indicates differences were not statistically significant