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The myth of private-sector performance pay

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Snapshot for May 13, 2009

The myth of private-sector performance pay

by Joydeep Roy

Proponents of pay-for-performance for teachers argue that such compensation models are ubiquitous in the private sector. For example, billionaire housing entrepreneur Eli Broad recently asserted that he “could not think of any other profession that does not have any rewards for excellence.”1 However, a new EPI book shows that this conventional wisdom is inaccurate.

In Teachers, Performance Pay, and Accountability, economists Scott Adams and John Heywood conduct one of the first systematic analyses of pay-for-performance practices in the private sector. They find that, contrary to the claims by advocates of teacher merit pay, “relatively few private-sector workers have pay that varies in a direct, formulaic way with their productivity, and that the share of such workers is probably declining.” The chart below compares the available data from 1976 and 1998 taken from a highly respected survey of U.S. workers, the Panel Study of Income Dynamics (PSID).2 Far from being widespread, the share of workers receiving bonuses, commissions, or piece rates ranges from about 1% to a maximum of about 12%.

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Less than 1% of the workers reported getting any “piece work” rates in either 1976 or 1998, and only 3-4% received commissions. Even the largest category — bonuses — only accounted for 10-11% of all workers. Overall, performance pay only affected about one in seven workers, and even then such pay represented only a small portion of their total compensation.

The chart also shows that pay-for-performance trends have not changed significantly in the last few decades. Moreover, looking at the different types of performance pay, the use of bonuses has increased, while the use of the more formulaic commissions and piece rates has decreased. Note, however, that even bonuses (as defined in the PSID survey) do not have to be explicitly tied to performance, unlike the proposed merit pay schemes for teachers. In other words, the actual prevalence of performance pay in the private sector is likely even less than the chart suggests.

Notes
1. Hoff, David J.  2008. Teacher-pay issue is hot in DNC discussions. Education Week. August 25.

2. Note that these numbers refer to actual receipt of performance pay in the current year.  The number of workers covered by performance pay schemes is likely to be higher, since not all workers actually covered by such schemes will receive them in every year. Unfortunately, the PSID survey does not allow one to directly compute coverage data — see Adams and Heywood (2009) for a reference to other studies that do so using other surveys.


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