On the role of learning, human capital and performance incentives for wages by Fabian Lange

Join us for the latest Applied Economics Research Seminar Series event, Autumn Term 2022.

Fabian Lange from McGill University will present On the role of learning, human capital and performance incentives for wages.

Abstract

Performance pay for most workers makes up only a small fraction of total pay. In this paper, we show that performance pay is nevertheless important for the dynamics of wages over the life cycle because of the incentives it provides for human capital acquisition. We argue so within a model that combines three key mechanisms for wage growth and dispersion, namely, human capital accumulation on the job, employer learning about workers’ ability, and performance incentives. We use this model to account for the experience profile of wages, their dispersion, and their composition in terms of fixed and variable (performance) pay.

Our model admits a decomposition of performance pay over the life cycle into four terms that capture: i) the trade-off between risk and incentives characteristic of moral-hazard situations; ii) the insurance that firms provide against uncertainty about ability; iii) incentives for effort due to this uncertainty (career concerns); and iv) incentives for effort from human capital acquisition.

Despite its parsimony, the model fits the data very well, including the observation that performance pay as a share of total pay, which measures the sensitivity of pay to performance, first increases and then declines with experience after peaking at around 20 years, contrary to the prediction of standard models that this ratio should be increasing especially at the end of the life cycle. Our estimates imply that human capital acquisition and insurance against uncertainty about ability are quantitatively the most important determinants of the sensitivity of pay to performance. Importantly, we also find that through the cumulative impact of effort on human capital acquisition, incentives for performance are a critical source of wage growth and dispersion over the life cycle.

The seminar will begin with a presentation and will end with a Q and A session.

It will be held in the Economics Common Room at 2pm on Thursday 15th December. This event is open to all levels of study and is also open to the public. To register your place and gain access to the webinar, please contact the seminar organisers.

This event is part of the Applied Economics Research Seminar Series.