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E-MailCristina J. Tello-Trillo is an economist at the U.S. Census Bureau Center for Economic Studies, and Adjunct Professor at the University of Maryland and Johns Hopkins University. This post is based on a recent paper authored by Ms. Tello-Trillo; Scott W. Ohlmacher, economist at the U.S. Census Bureau Center for Economic Studies; Nicholas A. Bloom, William Eberle Professor of Economics at Stanford University; and Melanie Wallskog, PhD candidate in economics at Stanford University.
In the paper Pay, Productivity and Management recently published on the NBER working paper series we study the relationship between productivity, management, and worker’s pay. Using confidential Census matched employer-employee earnings data we find that employees at more productive firms have substantially higher mean pay and higher pay across all percentiles of the earnings distribution. Not only are executive earnings higher but so are earnings at every level, from the 1st percentile upwards. In particular, a 10% increase in productivity is associated with a 0.7% increase in mean pay. This increase is not equally distributed across workers at the firm: a 10% increase in productivity predicts a 1.3% increase in pay for earners at the top 99th percentile (the C-suite), a 0.82% increase in pay for earners at the 90th percentile and only a 0.51% increase in pay for earners at the 10th percentile. We can observe the effects across all percentiles in figure 1.
We also find that a 10% increase in firm productivity implies an increase in within-firm inequality across several measures of inequality. For example, a 10% increase in productivity predicts a widening of the gap between the pay of the top earner—likely the Chief Executive Officer (CEO)—and the median worker’s pay by 0.8%. In terms of the aggregate distribution of productivity, these patterns are economically large. Moving from the 10th to the 90th percentile in the distribution of productivity in our main sample, predicts an increase in average pay of 20% and an increase in the gap between the top earners and median worker’s pay of 26%.
We also find that this pay-performance link holds in both public and private firms, although it is almost twice as strong in public firms for the highest paid workers. The highest paid worker (e.g. CEO) sees a 16.4% pay increase in public firms but only a 9.4% pay increase in private firms for a doubling a productivity. Lower ranks, in particular employees outside the top 50 highest paid, display similar performance-pay relationships in public and private firms.
Management and Pay
We further explore the role of performance-based pay by considering a correlate of productivity: management practices. From the Managerial and Organizational Practices Survey (MOPS) we have a measure of the degree to which a firm utilizes structured management practices. The measure incorporates both how organized the firm’s production process is and how it incentivizes workers. The management scores are normalized between 0 and 1, a value of 1 denotes firms with highly structured management practices and 0 denotes firms with no structured management practices, the mean value for firms in our sample is of 0.67.
The patterns we see between productivity and pay are also present for management and pay. Firms with more structured management tend to have higher average pay and larger inequality. In terms of the aggregate distribution of management, these patterns are economically large. Moving from the 10th to the 90th percentile in the distribution of management is associated with an increase in average pay of 6.3% and an increase in the gap between the top earner’s pay and the median worker’s pay of 26%.
Pay volatility
Another possible implication of more performance-based pay for top earners is that top earners should experience more within-year pay volatility at more productive firms, for instance because a larger share of their income may come through bonuses. We measure within-year pay volatility as the standard deviation in quarterly log earnings, within a given year. We find that earners at more productive firms and firm with structured management practices are more likely to have higher within-year pay volatility, and this is particularly true for the very top earners. One explanation is that more productive firms adopt more aggressive management practices – more intensive monitoring and aggressive performance pay schemes – which leads to both higher levels of pay but also higher volatility of pay.
Conclusion
We use confidential Census matched employer-employee earnings data to study the relationships between pay, productivity, and management practices. We find that employees at more productive firms and firms with more structured management practices have substantially higher pay, both on average and across every percentile of the pay distribution. This pay-performance relationship is particularly strong amongst top paid executives, with a doubling of firm productivity associated with 11% more pay for the highest-paid employee (likely the CEO) compared to 4.7% for the median worker. This pay-performance link holds in public and private firms, although is almost twice as strong in public firms for the highest paid executives. Top-executive pay volatility is also strongly related to productivity and structure managed, suggesting this performance-pay relationship arises from more aggressive monitoring and incentive practices amongst top executives.
The complete paper is available for download here.
