Incentive pay and the wage structure of firms: Evidence from a panel of Dutch firms

Does incentive pay affect the wage structure of firms? Does the way individual productivity is measured matter for such effects? The aim of this paper is to analyze the wage structure of Dutch firms to answer these questions about the relation of wage structure and incentive pay. We use biennial data covering the period 1993-2001 from a panel of 3,000 Dutch establishments with detailed information about the wage structure of the establishment, background characteristics, along with the wage policy of the firm. It is the first representative study about the wage structure of firms in the Netherlands. In the cross-section firms using subjective evaluations to determine incentive pay, we find on average 4% higher wages with a 20% higher variance. Panel estimates of the effect of incentive pay on the wage distribution, using fixed establishment effects, reveal that changes in the variance of the distribution similar to the cross-sectional results, indicating that the incentive scheme fully accounts for these differences between firms. It takes about three years before this increase in variance is realized. The introduction of incentive schemes based on subjective evaluations increases the average wage by 1.6%. We find no effects for incentive schemes based on objective standards, no effect for the skewness and only a short run effect for the kurtosis of the wage distribution. Incentive pay based on objective standards is related to a higher job turnover, while workers in firms with subjective evaluations tend to stay longer in their firm.