On the Role of Learning, Human Capital, and Performance Incentives for Wages

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IZA Seminar

Place: Schaumburg-Lippe-Str. 9, 53113 Bonn

Date: 15.06.2021, 14:45 - 16:00

   

Presentation by 

Fabian Lange (McGill University)
   

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https://us02web.zoom.us/j/87487213161

Meeting ID: 874 8721 3161

   

Abstract:

Standard models of performance incentives over the life cycle, so-called career-concerns models, imply that
implicit incentives for performance from workers’ concerns about their future careers progressively weaken as
workers accumulate labor market experience. To compensate, explicit incentives from performance pay should
correspondingly strengthen. Based on U.S. survey data and personnel records, we document that performance pay
relative to total pay instead declines over the last 20 years of workers’ careers. To address this evidence at odds
with standard models of incentives, we propose a novel tractable model of the labor market that accounts for the
experience profile of wages, their dispersion, and their composition in terms of fixed and variable (performance)
pay. The model combines human capital acquisition with experience through learning-by-doing, uncertainty and
learning about workers’ ability, and performance incentives. We show that incorporating human capital acquisition
can reconcile the theory with the data. Intuitively, in our model, effort on the job not only increases a worker’s
output but also augments a worker’s human capital. Since the returns to investing in human capital through
effort are high early in the life cycle but eventually decline with experience, the model naturally rationalizes the
hump-shaped profile of performance pay relative to total pay over the life cycle observed in the data. Formally,
we characterize equilibrium wages and analytically decompose the ratio of performance pay to total pay, which
measures the sensitivity of pay to performance, 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 from career concerns; and iv) incentives for effort from human capital acquisition.
Using this decomposition, we determine conditions for alternative life-cycle profiles of the sensitivity of pay to
performance to arise and, conversely, show that panel data on wages and their variable component are sufficient
to identify the model. The estimated model reproduces well the data. We estimate that human capital acquisition
and insurance against uncertainty about ability are quantitatively the most important determinants of the sensitivity
of pay to performance. 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.

   
   
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