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Do Salaries Improve Worker Performance? Do Salaries Improve Worker Performance?

We establish the effects of salaries on worker performance by exploiting a natural experiment in which some workers in a particular occupation (football referees) switch from short-term contracts to salaried contracts. Worker performance improves among those who move onto salaried contracts relative to those who do not. The finding is robust to the introduction of worker fixed effects indicating that it is not driven by better workers being awarded salary contracts. Nor is it sensitive to workers sorting into or out of the profession. Improved performance could arise from the additional effort workers exert due to career concerns, the higher income associated with career contracts (an efficiency wage effect) or improvements in worker quality arising from off-the-job training which accompanies the salaried contracts. 1. INTRODUCTION Although psychologists point to the inherent value of work to human beings and identify the beneficial impact it has on their wellbeing, the rational economic behavioural model underpinning labour economics equates effort with disutility. As such, economists assume employees are motivated by monetary rewards. Furthermore, they can be induced to expend greater effort in a task if those efforts are rewarded directly through performance-related pay. Although performance-related pay contracts are increasingly common, most workers receive an annual salary. If some of their income is tied to performance, it usually constitutes only a relatively small amount of total remuneration. One reason for the preponderance of salaried contracts is that workers are risk-averse and may be disinclined to share the risk of poor performance with their employer. Salaried employment minimises fluctuations in pay, thus giving workers some degree of certainty about their income into the future, provided they reach the performance threshold necessary to retain their job and provided the employer remains in business. Where workers are heterogeneous they may choose between contract types according to their risk preferences and their ability. Employers wishing to share risk with workers may be willing to pay a wage premium for performance-related contracts. More able workers may seek performance-related contracts in the expectation that this will provide them with a higher income than a standard contract (Lazear, 1986; Prendergast, 1999: 14-15). However, workers in a particular profession or occupation are not normally free to choose between contract types, either because a profession is characterised by a particular 4 type of contract or because, if there are various types of contract on offer, the employer may be the arbiter of who …