An Empirical Analysis of Pay Systems William E. Encinosa, University of Michigan Martin Gaynor, Carnegie Mellon University James B. Rebitzer, Massachusetts Institute of Technology Firms exhibit enormous variation in the degree to which compensation responds to individual performance. Explaining this diversity is one of the fundamental tasks for the economics of organizations. This paper incorporates the sociological concept of group norms into an economic analysis of the variation in observed pay systems.
Norms are the result of interpersonal comparisons of income and effort made by members of a group.
In our model, these comparisons lead to envy, shame and guilt. The consequence of these norms is that groups will optimally adopt less than 1st-best incentives. The key question is whether the predictions of this model can be empirically distinguished from a more conventional model in which groups also optimally adopt less than 1st-best incentives. We compare the predictions of the norms model with a conventional model in which groups trade off incentives in order to provide insurance from exogenous shocks to income. We test these predictions using a unique data set on physician group practices which contains information on incentive pay, group size, and other features of the group and its members.