Personnel Economics
2020-2021
Assignment Lecture 4
Student: Student number:
Date: 01-12-2020
Word count: 1351
, Assignment Lecture 4 on Personnel Economics
Assignment about incentive pay
a. Which two main effects explain the change in productivity when firms change from an
hourly wage to incentive pay (i.e. Lazear 2000)? Explain these two effects.
According to Lazear (2000), the change in productivity is caused by incentive effects that the workers
within firms experience and by the ability to hire the most productive workers.
Firstly, an incentive can be defined as “something that encourages a person to do something”
(Cambridge Dictionary, n.d.). Employee incentives, as explained by Lazear and Gibbs (2015), are a
very important source of value creation and can be motivational levers for employees. In an hourly
wage schedule, workers are paid according to the minimum acceptable output within the firm.
Workers have little incentives to increase their productivity to reach output levels above the minimum
acceptable output. On the other hand, when a firm shifts to incentive pay, for example by a piece-rate
scheme, workers have more incentives to increase their effort. Low-ability employees will be
indifferent, but high-ability employees that are willing to put in more effort can reap the benefits of
higher wages when they produce more. Therefore, the change in productivity will be caused by an
increase in the workers output and an increase in average ability, “because the ability of the lowest-
quality workers does not change as a result of the switch in compensation scheme, but the ability of
the highest-quality worker rises” (Lazear, 2000, p.1350).
Secondly, productivity increases as the firm will be able to hire the most productive workers. This is
also known as the process of sorting. After switching from hourly wages to incentive pay, the group of
workers in a firm can change, where the workers that are not making it get fired or quit early (Lazear,
2000). Subsequently, the firm is able to recruit new hires that have higher ability and that are thus
more likely to produce large outputs. The importance of turnover and sorting was also highlighted by
Lazear and Gibbs (2015) who stated that due to turnover (in this case turnover of low-ability
employees) the opportunity to hire more talented workers increases. It is a win-win for both the firm
and the workers, as the high-ability workers increase the firms’ productivity, and at the same time
these workers receive higher wages under the incentive pay scheme.
b. How successful was the change from an hourly wage to incentive pay at Safelite Glass
Corporation (Lazear, 2000)? Why is it so (un)successful?
At the Safelite Glass Corporation, the change from an hourly wage to incentive pay was very
successful. This is due to several reasons. Firstly, due to the change, there was an overall gain in
productivity of 44%. As previously explained, this productivity gain was caused by the incentive pay
2
2020-2021
Assignment Lecture 4
Student: Student number:
Date: 01-12-2020
Word count: 1351
, Assignment Lecture 4 on Personnel Economics
Assignment about incentive pay
a. Which two main effects explain the change in productivity when firms change from an
hourly wage to incentive pay (i.e. Lazear 2000)? Explain these two effects.
According to Lazear (2000), the change in productivity is caused by incentive effects that the workers
within firms experience and by the ability to hire the most productive workers.
Firstly, an incentive can be defined as “something that encourages a person to do something”
(Cambridge Dictionary, n.d.). Employee incentives, as explained by Lazear and Gibbs (2015), are a
very important source of value creation and can be motivational levers for employees. In an hourly
wage schedule, workers are paid according to the minimum acceptable output within the firm.
Workers have little incentives to increase their productivity to reach output levels above the minimum
acceptable output. On the other hand, when a firm shifts to incentive pay, for example by a piece-rate
scheme, workers have more incentives to increase their effort. Low-ability employees will be
indifferent, but high-ability employees that are willing to put in more effort can reap the benefits of
higher wages when they produce more. Therefore, the change in productivity will be caused by an
increase in the workers output and an increase in average ability, “because the ability of the lowest-
quality workers does not change as a result of the switch in compensation scheme, but the ability of
the highest-quality worker rises” (Lazear, 2000, p.1350).
Secondly, productivity increases as the firm will be able to hire the most productive workers. This is
also known as the process of sorting. After switching from hourly wages to incentive pay, the group of
workers in a firm can change, where the workers that are not making it get fired or quit early (Lazear,
2000). Subsequently, the firm is able to recruit new hires that have higher ability and that are thus
more likely to produce large outputs. The importance of turnover and sorting was also highlighted by
Lazear and Gibbs (2015) who stated that due to turnover (in this case turnover of low-ability
employees) the opportunity to hire more talented workers increases. It is a win-win for both the firm
and the workers, as the high-ability workers increase the firms’ productivity, and at the same time
these workers receive higher wages under the incentive pay scheme.
b. How successful was the change from an hourly wage to incentive pay at Safelite Glass
Corporation (Lazear, 2000)? Why is it so (un)successful?
At the Safelite Glass Corporation, the change from an hourly wage to incentive pay was very
successful. This is due to several reasons. Firstly, due to the change, there was an overall gain in
productivity of 44%. As previously explained, this productivity gain was caused by the incentive pay
2
