Wage Dispersion and Firm Productivity in Different Working Environments
| DOI | http://doi.org/10.1111/j.1467-8543.2009.00775.x |
| Date | 01 September 2011 |
| Author | Mélanie Volral,Benoît Mahy,François Rycx |
| Published date | 01 September 2011 |
Wage Dispersion and Firm Productivity
in Different Working Environmentsbjir_775 460..485
Benoît Mahy, François Rycx and Mélanie Volral
Abstract
This article investigates the impact of wage dispersion on firm productivity in
different working environments. More precisely, it examines the interaction
with: (i) the skills of the workforce, using a more appropriate indicator than the
standard distinction between white- and blue-collar workers, and (ii) the uncer-
tainty of the firm economic environment, which has, to our knowledge, never
been explored on an empirical basis. Using detailed cross-sectional linked
employer–employee data for Belgium, we find a hump-shaped relationship
between (conditional) wage dispersion and firm productivity. This result sug-
gests that up to (beyond) a certain level of wage dispersion, the incentive effects
of ‘tournaments’ dominate (are dominated by) ‘fairness’ and/or ‘sabotage’
considerations. Findings also show that the intensity of the relationship is
stronger for highly skilled workers and in more stable environments. This might
be explained by the fact that monitoring costs and production–effort elasticity
are greater for highly skilled workers, and that in the presence of high uncer-
tainty, workers have less control over their effort–output relation, and associate
higher uncertainty with more unfair environments.
1. Introduction
The potential influence of pay systems on workers’ productivity is a key issue
addressed by personnel economics. In this context, relative wages are often
considered to play a determining role. Assuming that workers compare their
wages with those of their co-workers when determining their level of effort,
wage dispersion should influence this level and hence average firm perfor-
mance. However, there is no clear theoretical consensus on the characteristics
of this relationship. First, the ‘tournament model’ proposed by Lazear and
Benoît Mahy is at the University of Mons — UMONS, Warocqué Research Center (CRW) and
Department of Applied Economics (DULBEA). François Rycx is at the Université Libre
de Bruxelles (ULB), Centre Emile Bernheim (CEB), Department of Applied Economics
(DULBEA) and IZA-Bonn. Mélanie Volral is at the University of Mons — UMONS and
Warocqué Research Center (CRW).
British Journal of Industrial Relations doi: 10.1111/j.1467-8543.2009.00775.x
49:3 September 2011 0007–1080 pp. 460–485
© Blackwell Publishing Ltd/London School of Economics 2010. Published by Blackwell Publishing Ltd,
9600 Garsington Road, Oxford OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA.
Rosen (1981) stresses that a more differentiated wage structure stimulates
workers’ effort, through the incentive resulting from awarding the largest
prize to the most productive worker. Their approach further suggests that the
higher the pay spread, the higher the workers’ optimal level of effort. In
contrast, other theories argue that wage compression, that is a lower disper-
sion, reinforces workers’ productivity by either improving labour relations
(Akerlof and Yellen 1988), sustaining and stimulating cohesiveness among
the workforce (Levine 1991), or preventing workers from engaging in costly
rent-seeking activities instead of productive work (Milgrom and Roberts
1990).
Given the importance of this issue,1a growing empirical literature is
devoted to analysing the relationship between wage dispersion and firm
performance (e.g. Eriksson 1999; Hibbs and Locking 2000; Lallemand et al.
2007; Martins 2008; Winter-Ebmer and Zweimüller 1999). Yet the precise
impact of wage dispersion on firm performance still remains unclear as both
positive and negative impacts are suggested. Moreover, studies considering
that this relationship might be influenced by specific working environments
are not that numerous, even though, as indicated by Pfeffer and Langton
(1993: 383), ‘one of the more useful avenues for research on pay systems may
be precisely this task of determining not which pay scheme is best but, rather,
under what conditions salary dispersion has positive effects and under what
conditions it has negative effects’. The optimal level of wage dispersion for
productivity might thus be relatively high or low depending on the charac-
teristics of the working environment under consideration.
Therefore, the aim of this article is to analyse the sign and magnitude of
the impact of wage dispersion on firm productivity in the Belgian private
sector, and to examine whether this relationship varies across different
working environments. On the one hand, we investigate the role played by
the skills of the workforce using a more appropriate indicator than the
standard distinction between white- and blue-collar workers. To do so, we
combine information on levels of education and occupations. On the other,
we analyse the interaction with the uncertainty of the firm economic envi-
ronment. This has, to our knowledge, never been explored before on an
empirical basis.2
In order to achieve these objectives, we use a large and detailed matched
employer–employee dataset for the year 2003 and compute a conditional
wage dispersion indicator, as suggested by Winter-Ebmer and Zweimüller
(1999). We test for a possible hump-shaped relationship between wage dis-
persion and firm productivity and address the potential simultaneity problem
between these variables. However, given that we do not have panel data, we
are unfortunately not able to control for unobserved workplace characteris-
tics by implementing fixed effects models.
The remainder of this article is organized as follows. Section 2 reviews the
literature regarding the impact of wage dispersion on firm performance. We
describe our methodology in section 3 and present the dataset in section 4.
Section 5 is devoted to a presentation and discussion of the impact of wage
Wage Dispersion and Firm Productivity 461
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